Applied Economics

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Doing well while doing good: ESG ratings and

corporate bond returns

Sebastian A. Gehricke, Xinfeng Ruan & Jin E. Zhang

To cite this article: Sebastian A. Gehricke, Xinfeng Ruan & Jin E. Zhang (2023): Doing well
while doing good: ESG ratings and corporate bond returns, Applied Economics, DOI:
10.1080/00036846.2023.2178624

To link to this article: https://doi.org/10.1080/00036846.2023.2178624

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Published online: 21 Feb 2023.

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APPLIED ECONOMICS
https://doi.org/10.1080/00036846.2023.2178624

Doing well while doing good: ESG ratings and corporate bond returns
a
Sebastian A. Gehricke , Xinfeng Ruanb and Jin E. Zhangb
a
Climate and Energy Finance Group (CEFGroup) and Senior Lecturer, Department of Accountancy and Finance, University of Otago, Dunedin,
New Zealand; bDepartment of Accountancy and Finance, Otago Business School, University of Otago, Dunedin, New Zealand

ABSTRACT KEYWORDS
The relationship between ESG performance and equity returns has become a popular area of ESG; sustainable investing;
research, but the same is not yet the case for bond returns. In this paper, we explore whether corporate bond returns;
incorporating ESG factors, beyond emissions into the bond portfolio investment process leads to responsible investing
under or out performance. We find that ESG investing in bond portfolios does not lead to over or JEL CLASSIFICATION
under performance. In other words, you do not have to ‘pay to do good’. Further, in the period G11; G12
since the Paris agreement, Energy sector bond portfolio returns are positively related to ESG
factors. This finding aligns with the theoretical prediction of Pedersen, Fitzgibbons, and
Pomorski (2020), namely, that the ESG-return relationship should become positive as investors
become more aware of ESG risks and opportunities. Overall, we show that Bond investors can ‘do
well while doing good’.

I. Introduction warming target. Companies that do not address

The global climate change emergency has acceler­
ated the transition to more sustainable business
practices in recent years. There is a vast literature
exploring, empirically and theoretically, the effect
of more responsible investment strategies on equity
portfolio returns, showing that these strategies
increase financial performance. However, far less
attention has been paid to bond investments. In
this article, we show that investing more responsi­
bly in bond markets does not lead to under or over
performance. Further, since the Paris agreement, as
investors become more aware of sustainability
issues, incorporating Environmental, Social and
Governance (ESG) factors in the investment pro­
cess can lead to outperformance in the Energy
industry.
Climate change has drawn investor and owner
attention towards ESG risks, opportunities and
impacts. Climate change brings with it many new
opportunities and risks for companies and inves­
tors. Just in the Energy sector, investment of 2.4
trillion USD per year is needed between 2016 and
2035 in order to stay in line with the 1.5 degrees of
climate change, by transitioning away from carbon
intense practices, already face increasing financing
costs due to new climate-related capital require­
ments and the general trend towards sustainable
investing (Krueger, Sautner, and Starks 2020). In
recent year’s investors and portfolio managers over­
seeing vast investments have been incorporating
ESG factors, beyond pure climate change issues, in
their investment processes to manage risks and
capture opportunities. This growth can be easily
seen in Figure 1, which plots the number of signa­
tories to the United Nations Principles of
Responsible Investing (UN PRI). Further, global
assets under management with ESG considerations
grew from 22.8 Trillion to 30.7 Trillion USD, from
2016 to 2018 (GSIA 2019) and are projected to be in
excess of 53 Trillion USD by 2025 using conserva­
tive growth assumptions (Bloomberg 2020). This
raises the question of how do the risks and oppor­
tunities of sustainability affect investment returns?
There is a developing literature providing equili­
brium models of the relationship between ESG
investing, investor ESG preferences/awareness and

CONTACT Xinfeng Ruan xinfeng.ruan@otago.ac.nz Department of Accountancy and Finance, Otago Business School, University of Otago, Dunedin
9054, New Zealand
© 2023 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group.
This is an Open Access article distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives License (http://creativecommons.org/licenses/by-nc-
nd/4.0/), which permits non-commercial re-use, distribution, and reproduction in any medium, provided the original work is properly cited, and is not altered, transformed, or built
upon in any way.
2 S. A. GEHRICKE ET AL.
4000
3500
3000
# of signatories
2500
2000
1500
1000
500
Figure 1. United Nations Principles of Responsible Investing (UNPRI) signatories. This Figure presents the cumulative number of
signatories to the UNPRI.
portfolio returns (Friedman and Heinle 2016; Pastor,
Stambaugh, and Taylor 2020; Pedersen, Fitzgibbons,
and Pomorski 2020). Pastor, Stambaugh, and Taylor
(2020) show that, in equilibrium, green assets will
have a negative alpha, while brown assets will have
a positive alpha. The negative alpha for green assets is
driven by investor preference for green assets, as
these can hedge climate risks. This exemplifies the
ESG risk premium hypothesis, namely, investors are
willing to give up some return in order to lower their
ESG risk1 Pastor, Stambaugh, and Taylor (2020)
further show that the alpha of green holdings can
be positive, reflecting the ESG alpha hypothesis,
when investor tastes (and sufficient investments)
shift to green assets, but this is counteracted when
we have vast dispersion in ESG preferences among
investors. Pedersen, Fitzgibbons, and Pomorski
(2020) add an ESG unaware mean-variance optimiz­
ing investor to their model and show that the larger
the unaware investors proportional wealth the lower
the returns to high ESG assets. Combining the theo­
retical findings of Pedersen, Fitzgibbons, and
Pomorski (2020) and Pastor, Stambaugh, and
Taylor (2020), whether there is outperformance or
underperformance related to ESG factors depends on
the dispersion of ESG preferences and the relative
awareness of ESG risks by investors.
In either the ESG alpha (outperformance related
to ESG) or the ESG risk premium (underperfor­
mance related to ESG) hypotheses, the performance
1
show that during the start of the COVID-19 pandemic investors preferred low-ESG risk funds..
of the assets is driven by the systematic risks asso­
ciated with poor ESG performance (Jin 2018).
Krueger, Sautner, and Starks (2020) show that insti­
tutional investors believe that climate risks have
material effects on their portfolios, while Amir and
Serafeim (2018) show that investors are integrating
ESG practices mainly for financial performance rea­
sons. For example, higher emissions indicate higher
climate risks such as regulatory intervention, carbon
pricing, commodity price risk (fossil fuels are burnt
and create emissions) and technology risk (for
example, cheaper renewable energy technology).
There are currently mixed empirical results on
the relationship between ESG performance and
financial performance (Auer and Schuhmacher
2016; Awaysheh et al. 2020; Revelli and Viviani
2015; Van Beurden and Gössling 2008). Several
studies have found a negative relationship between
ESG performance and financial performance. Luo
and Balvers (2017) for example, show that the
negative screening of the worst ESG performers
leads to outperformance in those excluded stocks.
However, most of the recent literature documents
a positive or non-negative relationship between
Corporate Social Responsibility (CSR) or ESG,
and financial performance (Busch and Friede
2018; Friede, Busch, and Bassen 2015; Margolis
et al. 2007; Margolis, Elfenbein, and Walsh 2012;
among others). Maiti (2020) shows that a three-
factor model with market, size and ESG factors

outperforms popular asset pricing models and
therefore ESG should be incorporated in the
investment decision process. Gao, He, and Li
(2022) show that positive media ESG spotlight sig­
nificantly reduces firms’ cost of debt especially for
firms with poor governance. Further, some studies
show that incorporating ESG factors into the
investment process leads to outperformance
(Ashwin Kumar et al. 2016; Pollard et al. 2017).
In a recent study Bolton and Kacperczyk (2021)
found that stocks of companies with higher total
carbon emissions, but not emission intensity,
underperform for the period 2005 to 2017. They
further show this is not driven by divestment, as
divestment activity is minimal and industry speci­
fic, but rather by investors pricing carbon risk.
Eccles, Verheyden, and Feiner (2016) show that
a 10% best in class ESG screen, that is removing
the 10% worst ESG performing companies (more
commonly called a negative screen), increases port­
folio performance across a large range of invest­
ment approaches in developed and undeveloped
markets.
Bond returns exhibit two important differences
to stock returns, namely they have limited upside
and are more exposed to downside risks (Bai, Bali,
and Wen 2019). Therefore, they will likely be
affected more by the predominantly downside
risks, such as stranded assets and increased finan­
cing costs, that come with poor ESG performance.
The increased downside risk of high emitting and/
or low ESG firms is also well documented in the
literature using realized returns (Jin 2018) and
option implied measures (Ilhan, Sautner, and
Vilkov 2018; Shafer and Szado 2019). Further,
Albuquerque et al. (2020) show that companies
with higher Environmental and Social performance
are more resilient to crisis by examining the
COVID-19 pandemic, which caused a major global
downturn. Following a similar theory as in stock
markets, only that the downside risks are even
more severe, bond returns may be positively (ESG
alpha) or negatively (ESG premium) related to ESG
performance, depending on the awareness and
integration of these risks by bond investors.
Many studies have explored the relationship
between ESG, at least the E component, and stock
returns, but studies on bond returns and ESG per­
formance are still few in number. Huynh and Xia
APPLIED ECONOMICS 3
(2020) show that corporate bond returns, which are
more sensitive to climate change news, earn lower
returns. This is consistent with the idea of higher
demand for bonds, which can be used to hedge
climate change. Duan, Li, and Wen (2020) explore
the relationship between environmental perfor­
mance of firms and their bond returns more
directly. They find a significant positive relation­
ship between lower carbon intensity and bond
returns, in line with the ESG (carbon) alpha
hypothesis, rather than the ESG (carbon) premium
hypothesis. Cao et al. (2021) follow a similar
approach to show that firms with higher emissions
experience worse liquidity conditions. Henke
(2016) shows that 103 socially responsible bond
funds in the US and European Union (EU) have
outperformed a matched sample of conventional
funds, attributable mostly to mitigation of ESG
risks through screening. Bahra and Thukral
(2020) show that ESG ratings are additive to tradi­
tional credit ratings and can be used to enhance
bond portfolio returns. Jang et al. (2020) show that
ESG performance leads to outperformance of their
bonds, in a Korean bond market sample. Kumar
and Khasnis (2020) show that the impact of a credit
downgrade on bond returns is lessened if the ESG
rating of the firm is high.
Some studies explore the relationship between
ESG performance and credit risk/performance in
other markets. Henisz and McGlinch (2019)
explore media controversies on indigenous land
claims and biodiversity as a mechanism for the
link between ESG and credit risk. Bae, Chang,
and Yi (2018b) and Bae, Chang, and Yi (2018a)
show that there is a relationship between CSR
strengths and concerns with syndicated and private
bank loan spreads, respectively.
In this study, we extend the work of Duan, Li,
and Wen (2020) by examining the relationship of
firms overall ESG, and specific E, S and
G performance, with bond returns, rather than
focussing on carbon intensity only. We analyse
this relationship using two approaches, firstly we
perform portfolio sorts on our corporate bond
return sample by E, S, G and ESG ratings and
explore the returns of high minus low (H-L) ESG
factor portfolios. We then calculate risk-adjusted
alphas to explore whether any ESG out or under
performance persists when we employ the well-
4 S. A. GEHRICKE ET AL.
accepted Carhart (1997) four-factor model.
Secondly, we explore the predictive power of ESG
factors for corporate bond returns, employing
a cross-sectional analysis with the well-established
bond return model of Bai, Bali, and Wen (2019).
We find that incorporating ESG factors does not
lead to out or under performance in bond portfo­
lios and ESG factors do not predict bond returns.
This shows that investors can create responsible
investment strategies in bond markets, without
having to pay a premium, but there is also no out­
performance associated with ESG factors in bond
portfolios over our sample period. This is similar to
the early results in equity markets as reported by
Hamilton, Jo, and Statman (1993). Therefore,
investors can do well while doing good, as doing
good does not decrease returns, in their bond
investments.
Pastor, Stambaugh, and Taylor (2020) show, in
an equilibrium model, that high ESG stocks could
outperform if investors ESG preferences strengthen
over the period analysed. Therefore, we study the
sub-sample since the Paris agreement was signed,
arguably the most significant global environmental
agreement to date. Again, we find that there is no
significant under or outperformance of bond
returns associated with ESG factors, even after
this important piece of regulation. It seems that
bond investors are not yet concerned with wider
ESG issues, although carbon emissions do affect
bond returns (Duan, Li, and Wen 2020). ESG
risks seem to not be priced significantly in bond
markets, although these could be the most exposed
to major downside risks.
Landry, Castillo-Lazaro, and Lee (2017) explore
the relationship, with some controls, between ESG
ratings and credit default spreads, finding that this
relationship is stronger in some sectors. Further,
Consolandi, Eccles, and Gabbi (2022), show that
ESG factors have more effect on equity returns in
sectors where such risks are more material. To
investigate if the more exposed Energy industry’s
bonds might be pricing ESG risks and opportu­
nities we split the sample into bonds of firms in
the Energy industry, as defined by the Industry
Classification Benchmark (ICB), and those not in
2
The ESG plus score is provided by Refinitiv and is the ESG score overlaid with their ESG controversies, which captures controversial ESG news for the target
company, so that the ESG score will be decreased if the company exhibits negative ESG news..
the Energy industry. The Energy industry faces vast
political and societal pressure for their emissions.
For the Energy sector, we find significant bond
portfolio outperformance associated with company
Environmental scores, in the post-Paris agreement
period. This shows that ESG risks and opportu­
nities are being priced in the Energy bond market,
but this is a recent phenomenon and is likely driven
by trends in
Our results show that incorporating ESG factors
into the bond investment process does not infer an
ESG premium for more responsible investing stra­
tegies. Our results are robust to using three differ­
ent ESG rating providers, Refinitiv, Sustainalytics
and Bloomberg ESG disclosure scores and the aver­
age of the three rating providers. This is important
as recent papers have found that ESG ratings
diverge significantly across providers (Berg,
Koelbel, and Rigobon 2022; Berg et al. 2022;
Chatterji et al. 2016). This differs to the more
mature ESG investing industry in equity markets,
which has driven a shift from the ESG alpha to the
ESG premium, likely through increased awareness
and demand by investors. Taken together with the
results of Duan, Li, and Wen (2020) this suggests
that bond investors can still enjoy a first mover
advantage, potentially being ‘paid to do good’ and
certainly not ‘paying to do good’, if they move to
a more responsible investing strategy, particularly
in the Energy industry.
The remainder of this paper is organized as fol­
lows. We begin by describing our sample in section
II. We report our method and empirical findings in
section III before concluding the paper in section IV.
II. Data
ESG data
Weekly Refinitv ESG data from January 2004 to
March 2020 is collected through DataStream. The
Refinitiv ESG database provides the Environmental
score (E score), Social score (S score), Governance
score (G score), ESG score (ESG score), and ESG
plus score (ESG+ score)2 Not all bond issuers ESG
scores are updated simultaneously and as with
financial reporting there is a lag effect from the

reported data.3 Therefore, to make sure the ESG
information is available to investors at the time we
are investigating performance, following Grullon,
Kaba, and Núñez-Torres (2020), we use ESG at the
end of year t-2 to examine bond returns in year t.
After incorporating this lag, our final sample is
from January 2006 to March 2020.
Panel A of Table 1 reports the time-series aver­
age of the cross-sectional ESG scores. We find that
the average S score and G score are 60.00 and 61.37,
respectively, which are higher than the average
E score at the value of 56.95. The average ESG
score is 58.16, which is higher than ESG+ score,
as can be expected as the ESG+ score incorporates
a negative adjustment when there are negative ESG
news for the company. The correlation between
ESG score and ESG+ score given in Panel B, is
0.58, which means that ESG score and ESG+
score are sufficiently different to motivate the
investigation of the ESG+ score in this paper. In
addition, we find that the E score and S score have
a high correlation at the value of 0.63. This reveals
that a firm with high E score tends to have high
S score. G score has a relatively low correlation
with E score and S score (i.e. 0.16 and 0.23).
Several studies have shown that ESG ratings
provided by different companies are not well cor­
related and seem to diverge (Berg, Koelbel, and
Rigobon 2022; Chatterji et al. 2016), which is dri­
ven mostly by scope and measurement divergence
rather than the weighting of ESG indicators (Berg,
Koelbel, and Rigobon 2022). To make sure our
results are not dependant on the Refinitiv ESG
ratings we re-run all of our analysis using the
Bloomberg ESG disclosure scores and the
Sustainalytics ESG rankings, accessed through the
Bloomberg Professional Services, and the average
of all three ESG provider scores. Berg et al. (2022)
have developed more sophisticated methodologies
for combining ESG ratings, but this is left for future
research as these methods are still in development.
Employing more ESG ratings data providers and
the relationship with bond returns is left for future
research, particularly the ratings from TruValue
Labs, which employ dynamic materiality (Bala
et al. 2020; Kuh et al. 2020) and can address
3
ESG information is collected by Refinitiv based on publicly available sources such as company websites, annual reports, and corporate social responsibility
reports or contributed by firms and then audited and standardized.
APPLIED ECONOMICS 5
some of the concerns of the important measure­
ment errors related to materiality described by
Yoon and Serafeim (2022).
Bond return data
The monthly bond returns data (RET_EOM) are
obtained from the Wharton Research Data Services
(WRDS) Bond Database. Although these data are
available from July 2002, due to the availability of
ESG data, we select the sample period from
January 2006 to March 2020. The WRDS database
follows the cleaning procedures outlined in
Asquith, Covert, and Pathak (2013) and Dick-
Nielsen (2009, 2013) to clean TRACE Enhanced
data. The WRDS Bond Database also provide the
offering date (OFFERING_DATE), offering
amount (OFFERING_AMT), offering price
(OFFERING_PRICE), FISD coupon rate
(COUPON), numerical rating (RATING_NUM),
time to maturity in years (TMT), bond price at
the end of month (PRICE_EOM) and total par-
value volume (T_Volume) variables. Following
(Bai, Bali, and Wen 2019), we further filter out
bonds that trade under $5 or above $1,000, have
less than one year to maturity or have transaction
records that have trading volume of less than
$10,000. Overall, our filtering criteria are consistent
with Bai, Bali, and Wen (2019).
Now we define the monthly excess bond returns
(ExRet) as
ExRett ¼ RETEOMt RFt ; (1)
where RF is the monthly risk-free rate (i.e. the one-
month Treasury bill rate) obtained from Kenneth
R. French Data Library via WRDS.
Panel A of Table 1 reports the time-series aver­
age of the cross-sectional excess bond returns. It
shows there are 487,132 bond month-return obser­
vations in our sample period. Moreover, we find
that the average excess bond return is 0.44% with
a large standard deviation of 3.07%. The percentiles
from 1st to 99th vary from−7.34% to 8.45%. These
summary statistics are very close to those reported
by Bai, Bali, and Wen (2019).
 6

Table 1. Summary statistics.

Percentiles
S. A. GEHRICKE ET AL.

N Mean Median Std. Dev. p1 p5 p25 p75 p95 p99

Panel A: Cross-sectional statistics over the sample period of Jan 2006 to Mar 2020
Excess bond returns (%) 487,132 0.44 0.34 3.07 −7.34 −3.39 −0.66 1.48 4.49 8.45
E score 520,131 56.95 59.62 22.67 2.83 13.86 42.41 74.97 86.65 90.24
S score 557,251 60.00 62.56 18.02 17.19 26.55 49.18 72.36 86.11 93.94
G score 557,751 61.37 64.23 19.00 13.41 28.10 47.97 76.06 88.23 92.78
ESG score 557,751 58.16 60.53 15.47 18.45 29.32 48.79 69.47 79.83 86.25
ESG+ score 557,751 46.34 43.21 14.64 17.81 26.25 35.69 56.39 73.02 80.74
BETA_BOND 306,006 1.01 0.86 0.69 −0.07 0.20 0.51 1.37 2.29 3.22
ILLIQ 440,463 1.16 0.18 3.53 −0.65 −0.13 0.02 0.80 5.22 19.16
RET_EOM (%) 482,146 0.52 0.41 3.05 −7.12 −3.27 −0.58 1.53 4.51 8.44
RATING_NUM 471,290 7.31 7.04 2.64 1.35 3.36 5.73 8.98 12.05 15.53
AGE 557,810 4.90 3.23 5.45 0.03 0.15 1.33 6.65 16.48 21.76
SIZE 557,875 52.81 34.13 65.10 0.16 0.68 13.08 65.67 182.17 298.41
TMT 554,965 9.41 5.67 9.64 1.05 1.33 2.98 11.40 28.37 30.82
COUPON (%) 557,687 4.50 4.87 2.39 0.00 0.18 3.14 6.08 7.92 9.24
Panel B: Average cross-sectional correlations
E score S score G score ESG score ESG+ score BETA ILLIQ RET_EOM RATING AGE SIZE TMT COUPON
E score 1.00 0.63 0.16 0.74 0.32 −0.01 0.00 0.00 −0.35 −0.03 0.08 −0.03 −0.23
S score 1.00 0.23 0.85 0.43 −0.04 −0.02 0.00 −0.45 −0.04 0.12 −0.04 −0.27
G score 1.00 0.60 0.46 0.00 0.01 −0.01 −0.19 0.01 0.04 0.04 −0.05
ESG score 1.00 0.58 −0.02 0.00 0.00 −0.46 −0.02 0.12 0.00 −0.24
ESG+ score 1.00 −0.05 0.01 −0.02 −0.23 0.09 0.08 0.13 0.12
BETA_BOND 1.00 0.09 0.05 0.14 −0.05 0.09 0.51 0.15
ILLIQ 1.00 0.00 0.02 0.25 −0.13 0.19 0.15
RET_EOM (%) 1.00 0.03 0.01 −0.02 0.03 0.01
RATING_NUM 1.00 0.03 −0.18 −0.06 0.35
AGE 1.00 −0.09 0.16 0.53
SIZE 1.00 0.06 0.21
TMT 1.00 0.35
COUPON 1.00
Panel A reports the number of bond-month observations, the cross-sectional mean, median, standard deviation and percentiles for monthly excess bond returns and bond characteristics including bond market beta (BETA),
illiquidity (ILLIQ), bond reversal (RET_EOM, %), credit rating (RATING), bond age in years (AGE), amount outstanding (SIZE, $ million), time-to-maturity (TMT, year), and the FISD coupon rate (COUPON, %). ASSET4 ESG data
including Environmental score (E score), Social score (S score), Governance score (G score), ESG score (ESG score), and ESG plus score (ESG+ score) in year t are the value at the end of year t-2. Panel B reports the time-series
average of the cross-sectional correlations. The sample period is from January 2006 to March 2020.
 APPLIED ECONOMICS 7

Bond characteristics data series analysis exploring the performance of E, S,

G, ESG and ESG+ sorted portfolios, in a univariate
For the bond illiquidity (ILLIQ), we get the daily
setting. We then examine the relationship between
bond price (PRICE) from TRACE Enhanced data
ESG factors and future return in a cross-sectional
file via WRDS. Following Bao, Pan, and Wang
regression, in both a univariate and multivariate
(2011) and Bai, Bali, and Wen (2019), we construct
setting.
ILLIQ as follows:
For each month, t, we form decile portfolios
�
ILLIQt ¼ Cov ΔPd;t ; ΔPdþ1;t ; (2) based upon each ESG factors (i.e. E score, S score,
G score, ESG score, and ESG+ score) in month
where ΔPd;t is the log price change for the bond t 1. Portfolio L contains stocks with the lowest
on day d of month t. ESG scores and Portfolio H contain stocks with the
The bond size in million dollars (SIZE) is highest ESG scores in the prior month. We calcu­
defined as the offering amount late the monthly equal- and value-weighted returns
(OFFERING_AMT) times offering price for each decile portfolio. After that, we also calcu­
(OFFERING_PRICE) divided by 1,000,000. We late high-minus-low (H-L) portfolio returns
calculate average size-weighted returns for all (RH L;t ) and their risk-adjusted alphas based on
bonds and for each month t as the market bond Carhart (1997) four-factor model as follows.
return (MKT_BOND). In line with Bai, Bali, and
Wen (2019), we run the following regression to RH L;t ¼ α þ β1 :MKTt þ β2 :SMBt þ β3 :HMLt þ β4 :UMDt þ et ;
estimate bond beta (BETA_BOND) using a ­ (4)
three year rolling window, as below4
where the market return factor (MKT), size factor
ExRetti ¼ αi þ BETA BONDi ðMKT BONDt RFt Þ þ eit ; (3) (SMB), value factor (HML), and momentum factor
(UMD) are obtained from Kenneth R. French Data
where eit is the regression residual.
Library via WRDS5
In addition, we calculate the bond age in years
Table 2 shows the average excess return of the
(AGE) using offering date (OFFERING_DATE), the
H-L portfolios and their risk-adjusted alphas, sorted
numerical rating (RATING_NUM) is to capture the
on the ESG factors in a univariate setting. We adjust
credit risk of bonds, the current bond return
test statistics using the method of (Newey and West
(RET_EOM) captures the bond reversal. FISD cou­
1987). From Table 2, we can see that none of the
pon rate (COUPON) and time to maturity in years
ESG factor high-minus-low (H-L) portfolios have
(TMT) are provided by the WRDS Bond Database.
significant out or under performance, as the average
Based on the time-series average of the cross-
excess return is not significantly different from zero.
sectional bond characteristics given in Panel A of
This provides the first evidence that incorporating
Table 1, we find that the average bond beta is 1.01
ESG factors in the portfolio formation process,
which is very close to one. The average bond illi­
therefore investing more responsibly, does not
quidity is 1.16. Furthermore, the average coupon
have to come at a cost, through lower returns.
rate, time to maturity, issue size, bond age and
Turning to the Carhart (1997) four-factor model
median rating are 4.50%, 9.41 years, and
alphas, we find very similar results. The E factor
$52.81 million, 4.90 years and BBB+, respectively.
equally weighted H-L portfolio alpha now becomes
significantly positive, at the 10% level, although the
III. Results significance dissipates for the value weighted
H-L portfolio. We can further see this represented
ESG ratings and bond portfolio performance
graphically in Figure 2, which presents
We now turn to our initial analysis of the ESG H-L cumulative returns over the sample. These
factors relationship with bond returns following results hint that there may actually be an opportu­
two approaches. The first approach is the time nity for outperformance when incorporating the
4
We require that there are at least two-years of data, i.e. at least 24 data points.
5
We also explore the bond market four factor model of (Bai et al. 2021), but for the reduced sample period ending into 2019 due to data availability, and our
conclusions are robust..
8 S. A. GEHRICKE ET AL.

E-factor in bond portfolio formation and maybe
a more complex strategy can take advantage of
this more directly. It is interesting to note that the
market return factor (MKT) seems to be the most
influential driver of bond returns.
Further, in Figure 2, ESG ratings, and particularly
the S score, may provide outperformance during
financial downturns as can be seen by the spike in
returns during the GFC. This would be consistent
with the results found in equity markets, that high
ESG (or at least E) performance companies are more
resilient during market downturns (Albuquerque
et al. 2020) and exhibit lower expected downside
risk, as measured by option market indicators
(Ilhan, Sautner, and Vilkov 2018; Shafer and Szado
2019).
Next, we run the Fama and Macbeth (1973)
cross-sectional regressions as follows:
factors, confirming the time series results above. The
only exception is the G score, which leads to sig­
nificantly lower next month bond returns, but only
when the control variables are included. Here, the
Bond beta (BETA_BOND), Illiquidity (ILLIQ) and
previous month return (RET_EOM) factors seem to
explain bond returns the most.
Overall, these results suggest that over our sample
period, January 2006 to March 2020, ESG perfor­
mance does not lead to under or over performance
in bond returns. This is an interesting finding, as
discussed earlier, as it seems bond returns do not
exhibit an ESG premium or ESG alpha effect and
this may be due to the lack of ESG preferences in the
institutional investor driven corporate bond market.
This could be explained by a lag in bond investors’
awareness of ESG risk factors, or intention to invest
responsibly relative to equity investors.

X
8
ExReti;t ¼ αi þ λ � ESGi;t þ γk � Xi;t þ eit ; (5)
k¼1
where ESGi;t is E score, S score, G score, ESG score,
or ESG+ score and Xi;t are the control variables
from Bai, Bali, and Wen (2019).
The results with Newey and West (1987) t-statis­
tics are presented in Table 3 first without any control
variables and then controlling for a comprehensive
list of established bond characteristic return factors
(Bai, Bali, and Wen 2019). We can see that none of
the ESG factors significantly affect next month bond
returns, on their own and when we control for other
Post Paris agreement
In an equilibrium model (Pastor, Stambaugh, and
Taylor 2020)) show that as the ESG concerns of
investors strengthen, green assets could outper­
form. To test this hypothesis in bond returns, we
repeat the above analysis, but only for the period
after the Paris agreement (December 2015 –
March 2020). The Paris agreement is the most
ambitious international agreement to combat cli­
mate change in history (Diaz-Rainey et al. 2021).
Diaz-Rainey et al. (2021) show that the Paris agree­
ment was more significant for the returns of the

Table 2. Full sample ESG sorted portfolio returns.

ESG score E score S score G score ESG+ score

H-L return α H-L return α H-L return α H-L return α H-L return α
Panel A: Equally Weighted Portfolios
−0.000592 −3.56e-05 0.00158 0.00178* 4.65e-05 0.000617 8.84e-05 0.000590 −0.00124 −0.000470
MKT −0.1110*** −0.0395 −0.117*** −0.0792*** −0.148***
SMB −0.0219 −0.0140 −0.0407 −0.00291 −0.0394
HML −0.0039 −0.0160 −0.0226 0.0249 −0.0160
UMD 0.0565* −0.0221 0.0342 0.0533** 0.0430
Obs. 169 169 170 170 170 170 170 170 170 170
Panel B: Value Weighted Portfolios
−0.000421 0.000105 −1.72e-05 0.000399 8.23e-05 0.000631 −9.21e-05 0.000314 −0.00101 −0.000173
MKT −0.114*** −0.0768** −0.118*** −0.0604*** −0.120***
SMB −0.0490 −0.0249 −0.0570 0.00210 −0.0262
HML −0.0155 −0.000337 −0.0276 0.0244 0.0499
UMD 0.0555 0.0305 0.0400 0.0370 0.0362
Obs 169 169 170 170 170 170 170 170 170 170
This table gives cumulative H-L portfolio returns and their risk-adjusted alphas based on Carhart (1997) four-factor model sorted based on E score, S score,
G score, ESG score, and ESG+ score, respectively. Panel A is based on equal-weighted H-L portfolio returns and Panel B is based on value-weighted
H-L portfolio returns. The sample period is from January 2006 to March 2020.
 APPLIED ECONOMICS 9

Panel A: Equally Weighted

Panel B: Value weighted

Figure 2. Cumulative returns to ESG bond portfolios. This Figure plots cumulative H-L portfolio returns sorted based on E score,
S score, G score, and ESG score, respectively, from 2006 to 2020. Panel A is based on equal-weighted H-L portfolio returns and Panel
B is based on value-weighted H-L portfolio returns.

fossil fuel industry than some other significant
climate policy events, such as the election of
Donald Trump to the U.S. presidency or his sub­
sequent withdrawal from the agreement.
In Table 4, we can see that the there is certainly no
significant under or out performance when ESG
factors are used to create bond portfolios, even
after the Paris agreement was signed. The equally
weighted E factor H-L portfolio does display
significant outperformance, at the 5% level of signif­
icance, in a univariate setting. Figure 2 shows this
graphically, as the cumulative returns of the equally
weighted H-L E score portfolio starts to trend
upward strongly after 2015. However, this outperfor­
mance becomes insignificant in the value weighted
portfolio and when we incorporate the other bond
return factors in the equally weighted portfolio.
Again, we see the dominance of the MKT factor.
 10
S. A. GEHRICKE ET AL.

Table 3. Full sample cross-sectional analysis.

ESG score E score S score G score ESG+ score
ESG indicator −0.000014 −0.000012 4.6e-06 1.1e-06 −0.000012 −6.3e-06 −0.000014 −0.00001** −0.000018 −4.7e-06
BETA_BOND 0.0028*** 0.0029** 0.0028*** 0.0028*** 0.0028***
ILLIQ 0.00015*** 0.00017*** 0.00015*** 0.00015*** 0.00015***
RET_EOM −0.24*** −0.25*** −0.24*** −0.24*** −0.24***
RATING_NUM 0.000034 0.000025 0.000048 0.000045 0.000066
AGE 0.000044 0.000017 0.000044 0.000043 0.000041
SIZE 0.00015 0.00016 0.00015 0.00012 0.000094
TMT 0.000059 0.000060 0.000059 0.000059 0.000058
COUPON 0.00016 0.00016 0.00016 0.00016 0.00016
Constant 0.0052*** 0.0015 0.0040*** 0.00092 0.0051*** 0.0010 0.0053*** 0.0015 0.0052*** 0.00082
Obs. 487,009 279,768 451,154 258,515 486,514 279,516 487,009 279,768 487,009 279,768
R-squared 0.004 0.247 0.005 0.260 0.004 0.247 0.002 0.247 0.010 0.247
Number of groups 171 171 171 171 171 171 171 171 171 171
This table reports the average intercept and slope coefficients from the Fama and Macbeth (1973) cross-sectional regressions of one-month-ahead bond excess returns on E score, S score, G score, ESG score, and ESG+ score,
respectively, with and without control variables. The sample period is from January 2006 to March 2020.
 APPLIED ECONOMICS 11

Table 4. Post-Paris ESG sorted portfolio returns.

ESG score E score S score G score ESG+ score

H-L return α H-L return α H-L return α H-L return α H-L return α
Panel A: Equally Weighted Portfolios
0.000878 0.000486 0.00442** 0.00320 0.000672 0.000523 0.000934 0.00112 0.000367 0.000847
MKT −0.0726*** −0.00356 −0.124*** −0.0671*** −0.197***
SMB 0.00641 −0.102 −0.00695 0.0131 0.0380
HML −0.124*** −0.155 −0.150** −0.0482 −0.139***
UMD −0.0662* −0.0774 −0.0660 −0.0279 0.00370
Obs. 49 49 50 50 50 50 50 50 50 50
Panel B: Value Weighted Portfolios
0.00130 0.000830 0.00127 0.000897 0.000729 0.000734 0.00109 0.00123 0.00109 0.00150
MKT −0.108*** −0.121** −0.168*** −0.0476** −0.0609**
SMB 0.0155 −0.0253 0.0196 0.0272 0.0325
HML −0.166*** −0.175* −0.177** −0.0415* −0.0116
UMD −0.0706* −0.0702 −0.0472 −0.0543 0.00508
Obs. 49 49 50 50 50 50 50 50 50 50
This table gives cumulative H-L portfolio returns and their risk-adjusted alphas based on Carhart (1997) four-factor model sorted based on E score, S score,
G score, ESG score, and ESG+ score, respectively. Panel A is based on equal-weighted H-L portfolio returns and Panel B is based on value-weighted
H-L portfolio returns. The subsample period is from December 2015 to March 2020.

Table 5. Post-paris cross-sectional analysis.

ESG score E score S score G score ESG+ score
ESG indicator 7.8e-06 −0.000010 0.000021* 2.4e-06 2.2e-06 −8.1e-06 −6.6e-06 −0.000010 −3.6e-06 1.9e-06
BETA_BOND 0.0043*** 0.0043*** 0.0042*** 0.0043*** 0.0043***
ILLIQ 0.00016** 0.00019** 0.00017** 0.00016** 0.00016**
RET_EOM −0.20*** −0.20*** −0.20*** −0.20*** −0.20***
RATING_NUM −0.000088 −0.000069 −0.000087 −0.000078 −0.000070
AGE −0.000023 −0.000033 −0.000022 −0.000027 −0.000027
SIZE 0.00034 0.00031 0.00034 0.00030 0.00031
TMT 0.000036 0.000033 0.000037 0.000037 0.000036
COUPON 0.00016 0.00018 0.00016 0.00017 0.00018
Constant 0.0040 0.00061 0.0032 −0.00036 0.0043 0.00050 0.0050** 0.00061 0.0047* −0.00026
Obs. 192,367 115,918 189,226 113,713 192,085 115,770 192,367 115,918 192,367 115,918
R-squared 0.002 0.268 0.003 0.270 0.003 0.268 0.002 0.268 0.011 0.268
Number of groups 51 51 51 51 51 51 51 51 51 51
This table reports the average intercept and slope coefficients from the Fama and Macbeth (1973) cross-sectional regressions of one-month-ahead bond excess
returns on E score, S score, G score, ESG score, and ESG+ score, respectively, with and without control variables. The subsample period is from December 2015
to March 2020.

This shows there is some potential for outperfor­
mance when incorporating Environmental factors,
in line with Duan, Li, and Wen (2020), who show
that bond portfolios outperform when incorporating
carbon intensity. This shows that bond investors are
not incorporating other environmental factors,
which are included in the E score, as strongly as
scope 1 and 2 Green House Gas (GHG) emissions
intensity, as they are for equity portfolios where
some studies have found significant outperformance
(ESG alpha) and underperformance (ESG risk pre­
mium), when incorporating ESG factors (Ashwin
Kumar et al. 2016; Bolton and Kacperczyk, 2021;
Busch and Friede 2018; Eccles, Verheyden, and
Feiner 2016; Friede, Busch, and Bassen 2015; Luo
and Balvers 2017; J. Margolis, Elfenbein, and Walsh
2012; Pollard et al. 2017; Revelli and Viviani 2015;
Van Beurden and Gössling 2008).
Further, in Table 5 we display the cross-sectional
regression results, defined in Equation (5), for the
post-Paris agreement sample period
(December 2015 – March 2020). The results are
very similar to the time-series analysis, the E factor
is positively related to next-month bond returns with
some significance, at the 10% level, but only in the
univariate setting. Once we add the control variables
the predictive power of the E factor is consumed by
the bond beta (BETA_BOND), illiquidity (ILLIQ)
and previous month return (RET_EOM) factors and
none of the ESG factors are related to under or out­
performance in the cross-section.
These findings are consistent with our full sample
results, which showed that incorporating ESG fac­
tors in the investment process does not lead to under
or over performance. This is still the case since the
Paris agreement. However, there is some evidence
12 S. A. GEHRICKE ET AL.

Table 6. Energy and non-energy ESG sorted portfolio returns: equally weighted portfolios.
ESG score E score S score G score ESG+ score

H-L return α H-L return α H-L return α H-L return α H-L return α
Panel A: Energy industry
−0.000335 8.02e-05 −0.000247 −0.000419 0.00324* 0.00324* −0.000525 −0.000110 −0.000295 3.39e-05
MKT −0.0470 0.00329 −0.0361 −0.0717 −0.0490
SMB −0.0745 −0.0386 0.0360 −0.0873 −0.0577
HML 0.109 −0.0184 −0.104 0.0602 0.0718
UMD 0.211* 0.157 −0.133 0.187* 0.191*
Observations 170 170 168 168 170 170 170 170 170 170
Panel B: Non-Energy industries
−0.000277 −0.000362 0.000279 5.12e-05 −0.000320 −0.000423 −0.000801*** −0.000763*** −0.000521 0.000163
MKT −0.00786 0.00795 0.00556 −0.00652 −0.104***
SMB −0.00986 0.00470 0.00374 0.00315 −0.0216
HML −0.0348 −0.0563 −0.0163 0.00275 0.0266
UMD 0.0138 −0.00451 0.0198 0.0115 0.0111
Observations 170 170 170 170 170 170 170 170 170 170
This table gives cumulative equal-weighted H-L portfolio returns and their risk-adjusted alphas based on Carhart (1997) four-factor model sorted based on
E score, S score, G score, ESG score, and ESG+ score, respectively. Panel A is for all energy companies and Panel B is all non-energy companies. The sample
period is from January 2006 to March 2020.

Table 7. Energy and non-energy ESG sorted portfolio returns: value weighted portfolios.
ESG score E score S score G score ESG+ score

H-L return α H-L return α H-L return α H-L return α H-L return α
Panel A: Energy industry
−0.000107 0.000270 0.000260 0.000233 0.00371* 0.00378* −0.000117 0.000235 0.000727 0.00100
MKT −0.0556 −0.0146 −0.0650 −0.0930 −0.0580
SMB −0.0723 −0.0208 0.0315 −0.0676 −0.0577
HML 0.0776 −0.0263 −0.147 −0.0166 0.0264
UMD 0.196* 0.101 −0.171 0.126 0.141
Observations 170 170 168 168 170 170 170 170 170 170
Panel B: Non-Energy industries
−0.000524 −0.000390 −0.000263 −0.000300 −0.000331 −0.000178 −0.000905*** −0.000896** −0.000479 −3.16e-05
MKT −0.0327 −0.0234 −0.0374** 0.0106 −0.0402**
SMB −0.0228 −0.00512 −0.0246 −0.00670 −0.0124
HML −0.0120 −0.0476 −0.0117 0.0253 0.0708
UMD 0.0116 0.0169* 0.0214 0.0105 0.0216
Observations 170 170 170 170 170 170 170 170 170 170
This table gives cumulative value-weighted H-L portfolio returns and their risk-adjusted alphas based on Carhart (1997) four-factor model sorted based on
E score, S score, G score, ESG score, and ESG+ score, respectively. Panel A is for all energy companies and Panel B is all non-energy companies. The sample
period is from January 2006 to March 2020.

that incorporating the environmental score (E) is
starting to improve bond portfolio performance
more recently.When we explore this relationship
with the ESG scores from the other two providers,
we get consistent results.
Energy sector
To explore the previous results further, we analysed
the performance of the Energy and non-Energy
industry bond returns, by splitting the sample and
applying the same methodology as above. 6 The
energy sector is most at risk of the most accepted/
prominent ESG issue, climate change, and
therefore presents the strongest case for incorpor­
ating ESG factors in the portfolio construction
process to outperform the market (Diaz-Rainey
et al. 2021).
Firstly, we explore the relationship between ESG
scores and bond portfolio returns for the full sam­
ple, as in Section 3.1, but separating firms into
Energy and non-Energy industry entities. The
results for the equally and value weighted portfolio
time series analysis are presented in Tables 6 and 7,
respectively. Different to the previous subsections,
we sort portfolios into two instead of ten portfolios,
as there are only 51 bonds per month on average
for the energy sector. Interestingly, using value or
equally weighted portfolios, we find that over the

6
The industry is defined using the Industry Classification Benchmark (ICB) accessed through the Bloomberg Professional Services.
 APPLIED ECONOMICS 13

Panel A: Equally Weighted Energy Companies Panel C: Equally Weighted non-Energy

Companies

Panel B: Value Weighted Energy Companies Panel D: Value Weighted non-Energy

Companies

Figure 3. Cumulative returns to ESG bond portfolios energy and non energy. This Figure plots cumulative H-L portfolio returns sorted
based on E score, S score, G score, and ESG score, respectively, from 2006 to 2020. Panel A is based on equal-weighted H-L portfolio
returns for all energy companies, Panel B is based on equal-weighted H-L portfolio returns for all non-energy companies, Panel C is
based on value-weighted H-L portfolio returns for all energy companies, and Panel D is based on value-weighted H-L portfolio returns
for all non-energy companies.

full sample the S score can lead to some outperfor­
mance for Energy company bond portfolios. In
Figure 3, we can see that this seems to be mainly
driven by the outperformance during Global
Financial Crisis (GFC) period. Further, incorporat­
ing the G score seems to lead to significant under­
performance for non-Energy industry bond
portfolios. These results hold with (Carhart 1997)
model adjusted alphas. When we turn to the cross-
sectional analysis in Table 8, the significance of the
S score fades, but the G score still leads to signifi­
cant underperformance for non-Energy industry
bonds, only after incorporating the control vari­
ables from (Bai, Bali, and Wen 2019). This shows
that the result for the G score also found in the full
sample analysis is driven by non-Energy
companies.
Next we want to explore the post-Paris relation­
ships as in section 3.2, but for the Energy and non-
Energy industry bonds. We first turn to the time
series approach, employing the portfolio sorts with
the ESG factors, the equally and value weighted
portfolio returns are presented in Tables 9 and 10,
respectively. We can see in the equally weighted
returns (Table 9) that the ESG and ESG+ sorted
Energy industry H-L bond portfolios exhibit statis­
tically significant outperformance, even when
employing the four factor model, at the 5% level
 14
S. A. GEHRICKE ET AL.

Table 8. Energy and non-energy cross-sectional analysis.

ESG score E score S score G score ESG+ score
Panel A: Energy Sector
ESG indicator −0.000018 −0.0011 0.000013 −0.00082 0.000075 0.00050 −0.000013 0.00035 6.8e-06 −0.0012
BETA_BOND −0.0041 0.0018 −0.0027 −0.0019 −0.0017
ILLIQ −0.00018 0.0049 2.1e-06 0.00045 −0.00017
RET_EOM −0.46*** −0.26*** −0.42*** −0.41*** −0.42***
RATING_NUM −0.026 0.0093 0.0026 0.00094 −0.032
AGE −0.00018 0.00011 −0.00015 0.00024 −0.00075**
SIZE −0.0050 0.00063 −0.0021 −0.0038 −0.0038
TMT 0.000046 0.00023 0.000044 −0.000032 0.000031
COUPON 0.0018** −0.0035 0.0016* 0.0021* 0.000099
Constant 0.0051 0.22 0.0042 −0.013 0.00073 −0.043 0.0045 −0.038 0.0039 0.28
Obs. 9,775 6,087 8,928 5,620 9,775 6,087 9,775 6,087 9,775 6,087
R-squared 0.048 0.623 0.051 0.679 0.043 0.623 0.055 0.626 0.045 0.623
Number of groups 171 171 171 171 171 171 171 171 171 171
Panel B: Not Energy Sectors
ESG indicator −0.000014 −0.000014 5.1e-06 9.7e-07 −0.000013 −7.2e-06 −0.000014 −0.000013*** −0.000018 −5.8e-06
BETA_BOND 0.0028*** 0.0028** 0.0028*** 0.0028*** 0.0028***
ILLIQ 0.00015*** 0.00017*** 0.00015*** 0.00015*** 0.00015***
RET_EOM −0.24*** −0.25*** −0.24*** −0.24*** −0.24***
RATING_NUM 0.000024 0.000019 0.000039 0.000039 0.000058
AGE 0.000044 0.000018 0.000044 0.000042 0.000040
SIZE 0.00016 0.00016 0.00015 0.00012 0.000095
TMT 0.000058 0.000060 0.000058 0.000058 0.000057
COUPON 0.00016 0.00016 0.00016 0.00017 0.00017
Constant 0.0052*** 0.0016 0.0040*** 0.00094 0.0051*** 0.0011 0.0052*** 0.0015 0.0053*** 0.00090
Obs. 477,234 273,681 442,226 252,895 476,739 273,429 477,234 273,681 477,234 273,681
R-squared 0.004 0.246 0.005 0.259 0.004 0.247 0.002 0.246 0.010 0.247
Number of groups 171 171 171 171 171 171 171 171 171 171
This table reports the average intercept and slope coefficients from the Fama and Macbeth (1973) cross-sectional regressions of one-month-ahead bond excess returns on E score, S score, G score, ESG score, and ESG+ score,
respectively, with and without control variables. Panel A is for all energy companies and Panel B is all non-energy companies. The sample period is from January 2006 to March 2020.
 APPLIED ECONOMICS 15

Table 9. Post-paris energy and non-energy ESG sorted portfolio returns: equally weighted portfolios.
ESG score E score S score G score ESG+ score

H-L return α H-L return α H-L return α H-L return α H-L return α
Panel A: Energy industry
0.00503** 0.00497** 0.00595*** 0.00576** 0.00415* 0.00361* 0.00177 0.00102 0.00470** 0.00478**
MKT −0.0994 −0.0939 −0.0790 −0.0823 −0.125*
SMB −0.0249 −0.0365 0.00186 0.00225 −0.00636
HML −0.111 −0.123 −0.154* −0.193*** −0.125
UMD −0.0704 −0.0936 −0.00887 −0.0711 −0.0989*
Observations 50 50 50 50 50 50 50 50 50 50
Panel B: Non-Energy industries
0.000297 1.27e-05 0.000314 1.03e-05 0.000502 0.000222 −0.000664 −0.000417 −0.000425 8.45e-05
MKT −0.0303 0.0238* 0.0180 −0.0271 −0.144***
SMB 0.00996 −0.0180 0.0131 0.0229* 0.0179
HML −0.0721** −0.0157 −0.0248 0.00213 −0.0775***
UMD −0.00823 −0.0180 −0.0131 0.00535 0.00461
Observations 50 50 50 50 50 50 50 50 50 50
This table gives cumulative equal-weighted H-L portfolio returns and their risk-adjusted alphas based on Carhart (1997) four-factor model sorted based on
E score, S score, G score, ESG score, and ESG+ score, respectively. Panel A is for all energy companies and Panel B is all non-energy companies. The subsample
period is from December 2015 to March 2020.

Table 10. Post-Paris energy and non-energy ESG sorted portfolio returns: value weighted portfolios.
ESG score E score S score G score ESG+ score

H-L return α H-L return α H-L return α H-L return α H-L return α
Panel A: Energy industry
0.00545** 0.00538** 0.00620** 0.00606** 0.00428* 0.00363* 0.00158 0.000716 0.00530** 0.00526**
MKT −0.111 −0.107 −0.0890 −0.108 −0.124
SMB −0.0332 −0.0407 −0.0207 0.0130 −0.0336
HML −0.124 −0.131 −0.177* −0.237*** −0.137
UMD −0.0970 −0.115 −0.0424 −0.0787 −0.119*
Observations 50 50 50 50 50 50 50 50 50 50
Panel B: Non-Energy industries
−8.42e-05 −5.22e-05 −0.000556 −0.000597 0.000131 0.000231 −9.75e-05 −1.53e-05 0.000204 0.000286
MKT −0.0604*** −0.0430*** −0.0631*** 0.00767 −0.00626
SMB 0.00995 0.0158 0.00281 0.0114 0.00894
HML −0.0594* −0.0533** −0.0533 0.0159 0.00321
UMD −0.0103 −0.0105 −0.0277 −0.00222 0.00292
Observations 50 50 50 50 50 50 50 50 50 50
This table gives cumulative value-weighted H-L portfolio returns and their risk-adjusted alphas based on Carhart (1997) four-factor model sorted based on
E score, S score, G score, ESG score, and ESG+ score, respectively. Panel A is for all energy companies and Panel B is all non-energy companies. The subsample
period is from December 2015 to March 2020.

of significance. Looking at the individual factor
portfolios we can see that this is mainly driven by
the E factor, which is significant at the 5% and 1%
level of significance for the univariate and four-
factor model results, respectively. The outperfor­
mance is also somewhat attributable to the S factor,
as portfolios formed on this have significantly posi­
tive returns at the 10% level, for both the univariate
and four-factor analysis. For non-Energy industry
bonds, we see that none of the ESG factors lead to
under or outperformance. Turning to the value-
weighted portfolios in Table 10, we find confirming
results, the ESG, ESG+, E and S factors lead to
outperformance for Energy industry bonds, even
when controlling for the four-factor model, but
only since the Paris agreement was signed in
2015. Figure 3 gives us a graphical representation
of this result, for Energy company bonds the cumu­
lative return trends upward for the E factor
H-L portfolios.
Turning to the cross-sectional analysis, in Table 11,
we see some significance of the E factor in the Energy
sector and still positive but less significant predictive
power in the non-Energy sectors. When we incorpo­
rate established bond characteristics as control vari­
ables (Balie et al. 2019), the significance disappears,
but there is no significant negative relationship either.
These results quite clearly indicate that in the
Energy sector, currently the most at risk sector to
climate change, bond investment strategies may
16 S. A. GEHRICKE ET AL.

Table 11. Post-Paris energy and non-energy cross-sectional analysis.

ESG score E score S score G score ESG+ score
Panel A: Energy Sector
ESG indicator 0.000095 0.000044 0.000075** 0.000017 0.000062 0.000033 0.00011 0.000094 0.000099 0.000046
BETA_BOND 0.0031 0.0030 0.0034 0.0034 0.0032
ILLIQ 0.0014 0.0015 0.0013* 0.0018 0.0014*
RET_EOM −0.31*** −0.31*** −0.31*** −0.33*** −0.32***
RATING_NUM −0.00031 −0.00031 −0.00027 −0.00013 −0.00036
AGE −0.000024 −1.0e-06 −0.000025 −0.000032 −0.000019
SIZE 0.00059 0.00076 0.00068 0.00058 0.00056
TMT 0.00016 0.00017 0.00013 0.00022 0.00015
COUPON −0.00023 −0.00038 −0.00026 −0.000029 −0.00019
Constant −0.0011 −0.00020 0.00012 0.0018 0.0012 −0.000046 −0.0023 −0.0055 −0.0012 −0.00010
Obs. 3,647 2,477 3,647 2,477 3,647 2,477 3,647 2,477 3,647 2,477
R-squared 0.060 0.580 0.034 0.577 0.065 0.579 0.081 0.593 0.059 0.581
Number of groups 51 51 51 51 51 51 51 51 51 51
Panel B: Not Energy Sectors
ESG indicator 6.0e-06 −0.000011 0.000020* 1.4e-06 1.2e-06 −8.6e-06 −7.3e-06 −9.7e-06 −6.2e-06 7.3e-07
BETA_BOND 0.0043*** 0.0043*** 0.0042*** 0.0042*** 0.0043***
ILLIQ 0.00016** 0.00019** 0.00017** 0.00016** 0.00016**
RET_EOM −0.20*** −0.20*** −0.20*** −0.20*** −0.20***
RATING_NUM −0.000085 −0.000066 −0.000084 −0.000073 −0.000066
AGE −0.000022 −0.000032 −0.000021 −0.000027 −0.000027
SIZE 0.00033 0.00031 0.00034 0.00029 0.00030
TMT 0.000035 0.000032 0.000037 0.000036 0.000035
COUPON 0.00017 0.00019 0.00017 0.00018 0.00018
Constant 0.0041 0.00063 0.0032 −0.00033 0.0044 0.00049 0.0050** 0.00053 0.0048* −0.00023
Obs. 188,720 113,441 185,579 111,236 188,438 113,293 188,720 113,441 188,720 113,441
R-squared 0.002 0.267 0.004 0.269 0.003 0.267 0.002 0.267 0.011 0.267
Number of groups 51 51 51 51 51 51 51 51 51 51
This table reports the average intercept and slope coefficients from the Fama and Macbeth (1973) cross-sectional regressions of one-month-ahead bond excess
returns on E score, S score, G score, ESG score, and ESG+ score, respectively, with and without control variables. Panel A is for all energy companies and Panel
B is all non-energy companies. The sub-sample period is from December 2015 to March 2020.

benefit from incorporating Environmental factors
and certainly do not face a loss of returns. In the
future as more of the risks and opportunities of
climate change become more prominently accepted
and even realized, other sector bond returns may
find similar outperformance when incorporating
E factors.
IV. Conclusion
Duan, Li, and Wen (2020) showed that incor­
porating emission intensity data in the bond
portfolio formation process leads to significant
outperformance. In this paper, we wanted to
explore whether incorporating wider ESG fac­
tors, into the bond investing process leads to
under or out performance. We find that this
does not lead to either. However, in the period
following the Paris agreement, Energy sector
bond portfolio returns are positively related to
ESG factors. This finding aligns with the model
of Pedersen, Fitzgibbons, and Pomorski (2020),
that shows that the ESG-return relationship
strengthens as investors become more aware of
ESG risks and opportunities. We argue that
investors in Energy sector bonds, especially
since the singing of the Paris agreement, would
be more aware of these fundamental ESG risks
and opportunities and are therefore the first to
account for this in their valuations of bonds.
Overall, our findings show that bond investors
can ‘do well’, if not better, by ‘doing good’.
We wanted to explore whether green bond port­
folios, with investors that are likely more aware of
ESG issues, would exhibit under or out performance
when incorporating ESG factors. Therefore, we
repeated all of the analysis for a subset of only
green bonds, as certified by the Climate Bonds
Initiative. Overall, we again found no under or
over performance attributable to ESG ratings.
To ensure our results are robust to the diver­
gence of ESG rating providers (Berg, Koelbel, and
Rigobon 2022; Chatterji et al. 2016) we explore all
of our analyses employing the Bloomberg ESG
disclosure scores and the Sustainalytics ESG rank­
ings and the average of all three ESG scores. Our
key finding remains the same; that is incorporating

ESG scores in bond portfolios does not lead to
under or over performance.
Acknowledgments
We would like to acknowledge the Climate and Energy
Finance Group for strong support on this work and the
Otago University Research Grant that enabled this research
to be carried out.
Disclosure statement
No potential conflict of interest was reported by the author(s).
ORCID
Sebastian A. Gehricke http://orcid.org/0000-0002-3251-
9275
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