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Hitendra Varsani, MSCI

MSCI rolls out fixed income ESG and factor indexes

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Earlier this month saw index and research provider MSCI launch 15 investment grade USD-denominated corporate bond indexes based on ESG and Factors.

Earlier this month saw index and research provider MSCI launch 15 investment grade USD-denominated corporate bond indexes based on ESG and Factors.

Hitendra Varsani, Factor Strategist at MSCI, explains that the launch of the two sets of fixed income indices was driven by client demand for targeted ESG and factor exposures in the fixed income space, as investors have begun to look more holistically at their portfolios and increasingly want to invest beyond equities.

The initiative is just the beginning of a huge body of work, Varsani says, as MSCI plans to expand its universe of fixed income offerings over the coming months and years. 

Varsani says: “ETF flows are biased towards high quality fixed income as it is the most liquid part of the universe so has fewer implementation challenges.” 

The plan is to move to other currencies, high yield within corporates and other sectors within fixed income going forward.

“Fixed income is not new within MSCI,” Varsani says, “what has changed is that we are launching indexes in specific strengths such as research factors that are ESG and beyond. Our goal is not to become a simple issuance weighted benchmark provider but to provide indexes that exploit our research.”

Varsani notes that the last 10 years have seen interest in ESG accelerating with all industry participants.

“There are three goals in ESG, the first and oldest is values based investing, putting capital in what you believe and value, but there is also Impact, changes that you want to see in the world and the largest is financial materiality, the impact ESG has on the financials of an issuer.” 

The equities of companies with high ESG values tend to exhibit higher return on investment, higher valuations, more robust business models and other high-quality characteristics. 

“ESG ratings are industry relative so we are looking for best in class in an industry as opposed to screening industries,” Varsani says. “We take a bird’s eye point of view as investors are becoming more intolerant of bad ESG incidences and regulation is also shifting, making ESG increasingly important and part of the fiduciary duty. Asset owners would like to engage with issuers more closely and they want more transparency.”

Investors can express their preference for high ESG companies by using their voting rights but that doesn’t apply to bonds. However, Varsani says that investors can engage with issuers by not providing finance unless certain standards have been met.

“Ongoing research examines what is the price of ESG on spreads,” Varsani says. “We have created a historical view of the impact of spread characteristics between an ESG-tilted index and one that is not and have found that ESG issuers tend to have narrower option spreads, or credit spreads.”

While it is quite well known now that equities have higher valuations with ESG, in corporate bonds, there is a similar pattern where the risk adjusted returns are in line or slightly higher on an absolute basis but the ESG score is materially higher, with maybe a 20 per cent improvement in the ESG profile without impacting the risk and return characteristics.”

“The question is, ‘is my ESG profile going to cost me performance?’” Varsani says. “And the answer is that in five years of research, the impact on the performance is small but the profile improvement is significant.”

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