Integrating the carbon footprint into the construction of corporate bond portfolios

Institutional investors, aware of the need to incorporate climate change as an additional risk factor into portfolio management, show a growing appetite for integrating Sustainable and Responsible Investment (SRI) criteria into their investment processes. Within a passive management context, this paper analyses, from a practical point of view, the inclusion of such criteria in the construction of corporate bond portfolios, thus incorporating a new dimension into the asset allocation process. We study the decarbonisation of a euro area corporate bond portfolio by constructing the efficient frontier, which shows the trade-off between the portfolio’s decarbonisation possibilities and the cost assumed in terms of deviation from the benchmark portfolio. We also analyse the impact of decarbonisation on the different risk-return parameters during the asset reallocation process. Finally, we present the main green investment strategies that investors can use to incorporate sustainability criteria into corporate bond portfolios’ design, introducing the Green-Parity approach as a complementary strategy to the available toolkit. The result of our empirical analysis, for the selected investment universe and sample period, shows that sustainability-conscious corporate bond investors have at their disposal different strategies that will allow them to achieve their decarbonisation objective without having to deviate significantly from their benchmark portfolio and to adequately meet the purely financial goals dictated by their investment mandate.