KKR & Co. expects that borrowers paying attention to environmental and social concerns will outperform in the U.S. corporate high-yield and leveraged loan markets.
As companies raise more environmental, social and governance-related capital, those with better scores are likely to outperform over time, according to a KKR report.
“We expect to see a technical shift, whereby highly rated ESG credits are rewarded with tighter spreads in the leveraged credit space. This creates opportunity for those that can be ahead of this trend,” according to the report.
The recent credit market selloff has been particularly hard on sustainable debt, challenging the popular premise that investors can do well and do good at the same time. With typically longer maturities, they’ve also been hit harder by the prospect of rising interest rates, contrary to the expectations that they’d hold up in volatile global markets.
While highly rated ESG companies in the bank loan and high yield markets are not being rewarded with lower credit spreads, companies with material ESG concerns — including those exposed to coal, oil sands, private prisons, or opioids — already trade at much wider levels in the junk market, according to KKR. Credits with material ESG concerns on average trade about 350 basis points wider than the market. The analysis evaluated over 1,085 credits in the course of a year.
The U.S. private equity firm expects the ESG premium to start to appear more clearly in the junk market as the industry evolves and as ESG disclosure and fund flows increase into this space, a similar pattern “akin to what we see with spread in credit rating agency ratings,” according to the report.
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