Trading Controversy in Corporate Bond Markets

Corporate misbehavior has a negative impact on a company's performance and valuation. Controversies expose an organization to severe materialities, including legal risk and loss of business opportunities. This can lead to strong negative price reactions on financial markets. Controversy scores have become popular among institutional investors as they seek to avoid corporate bond issuers embroiled in ongoing scandals.

RavenPack ESG Controversy Scoring Framework tracks news-based controversies, complementing more fundamental ESG-related information content.

In this paper, we leverage this framework to optimize bond selection, and demonstrate:

1. Financial materiality. Corporate bonds issued by organizations involved in severe controversies underperform both their benchmarks and credit portfolios composed of bonds with low or no controversy. This result is robust across daily, weekly, and monthly rebalancing frequencies. These bonds also experience higher volatility and spread duration.

2. Performance enhancement. When excluding securities, the Top-95% exclusion bond portfolio only trims nine controversial bond issuers at a two-month effective holding period, while adding 16 basis points (bps) and generating an information ratio of 0.76 in excess of the annual credit benchmark (see Figure below). Tilting the credit benchmark adds 9 bps to the annual benchmark at a six-month effective holding period, while mitigating volatility and maintaining a low tracking error and similar credit risk exposure.

3. Downside protection. Downside excess returns are substantially positive across all periods of bond market turmoil. This is particularly true when tilting more aggressively or when excluding more controversial bond issuers. The results confirm that fixed income securities issued by controversial companies tend to magnify downside beta.

Download the white paper to preview how our ESG Controversy Scoring Framework can improve your models.