Sustainable, responsible business practices and investment are a megatrend of our time, and we have been a pioneer in this field for many years. In this role, we have systematically built up and expanded the required comprehensive know-how, including a database and investment processes, over the past years. We are especially proud of the fact that we have achieved this with a very high degree of personnel continuity.

Raiffeisen-Euro-Corporates is green

The conversion of Raiffeisen-Euro-Corporates was another milestone on this path, and also makes perfect sense from a risk-return perspective. Since 19 September, the fund only invest in sustainable bond investments and is a sustainable fund as defined by Article 8 of the EU Sustainable Finance Disclosure Regulation*. This is also reflected in the new fund name: Raiffeisen-Euro-Corporates now is Raiffeisen-ESG-Euro-Corporates.

As in the past, the fund primarily invest in highly rated euro corporate bonds (the so-called investment grade segment) and to a relatively low extent (currently around 5%) in high yield bonds (i.e. bonds with lower ratings). What’s new is that the issuers of these bonds must be categorised as sustainable on the basis of ESG criteria for an investment to be considered.

Corporate bonds: why ESG criteria make sense

Responsible business practices and investment are now the talk of the town, but this is far more than just a “fashion trend” or politically-driven development. There are also good reasons for investors to pay more attention to ESG criteria from a risk-return perspective. Because all other things being equal, poorer ESG scores for a company should also manifest as higher business and financial risks, thus bringing generally lower credit ratings, possibly lower share prices, and higher risk premiums.

Corporate governance, the “G” in the ESG spectrum, is certainly the dominant of the three ESG factors across all sectors for bond investments, but is not the only factor that is important. In fact, corporate governance was already an important factor for a bond investment before the inception of the ESG concept because it can have a direct impact on event risk and credit ratings.

Credit ratings are without a doubt more important for spreads than ESG ratings. But good or poor actions by companies in terms of ESG do have an influence on their credit ratings. There is thus a relationship between ESG risks, default risks, and ultimately spreads and even the long-term performance of companies and their bonds.

Conclusion: This means that it pays off to take ESG criteria into account when assessing risks and selecting corporate bonds, including from a risk-return perspective!

Latest yield increases improving the risk-return constellations

The sharp price declines of recent months are little cause for joy with existing bond investments, but are ultimately the flip-side of the previous good returns over the past decade and the sustained period of ultra-low yields. Looking to the future, this opens up earnings potential that bond investors have yearned for for many years but that was nowhere to be found for more than a decade.

The markets are currently attempting to price in conditions where they will be left to their own devices, with no massive, direct and sustained market interventions by the European Central Bank. In fundamental terms, the currently still very good situation (interest rate coverage, debt levels, earnings, cash flows, extremely low default rates) will likely deteriorate in the coming quarters. At the same time, the European markets have priced a great deal in, including a mild recession scenario.

In this context, it is important to note that a substantial portion of the yield increase and spread widening is due less to a deterioration in the fundamental quality of the individual issuers than to the changed inflation and central bank environment and the capital flows (for example, retail investors have been conducting a great deal of selling recently). And there is no panic to be seen on the markets – neither among investors nor issuers. Another positive factor is that attractive new issue premiums are again being offered.

Further spread widening and yield increases as well as rising default rates are certainly possible (the latter practically unavoidable, in fact). But the achievable yields are now providing good compensation for these risks. Risks that are certainly not (yet) fully priced in include further and sustained geopolitical escalation and/or a deep recession, or further unexpected increases in inflation. An unexpected general withdrawal of substantial amounts of liquidity on the capital markets would also presumably have a negative impact on prices. On the other hand, decreasing inflation, a compromise in Ukraine, and/or at least a partial reduction in tensions and sanctions could also lead to more positive scenarios than the market is currently pricing in.

Volatility will surely persist for the foreseeable future, though this must also be kept in perspective: What now seem to be unusually high fluctuations were more or less normal up to ten years ago, until they were displaced by a period of extremely low volatility. This seems to be over for the time being. At the same time, the elevated risk of price volatility also offers better opportunities for active management. With that in mind, the fund management of Raiffeisen KAG is looking to the coming years with optimism despite the current challenging market situation.

* The Sustainable Finance Disclosure Regulation (SFDR) is an EU regulation that governs the disclosure obligations of financial services providers regarding the consideration of sustainability aspects in their processes and products. Article 8 SFDR: The fund takes environmental and/or social characteristics into account in the course of its investment process.