Geopolitical risks and ESG bonds: Portfolio implications for sustainable investing

This study investigates the influence of geopolitical risk on ESG-focused fixed income securities, including green, blue, climate, sustainability, social, and sukuk bonds. We employ time-varying parameter vector autoregressive connectedness and wavelet quantile correlation methodologies to analyse dynamic spillover effects and horizon-specific dependencies. The results demonstrate that aggregate geopolitical risk serves as a net transmitter of shocks to ESG bond markets. We identify significant heterogeneity in responses: green, climate, sustainability, and social bonds amplify spillovers, whereas blue bonds and sukuk act as net receivers. Wavelet analysis further reveals that these instruments provide limited long-term hedging benefits while showing vulnerability to short- and medium-term co-movements. Notably, our portfolio analysis demonstrates that a dynamic allocation strategy responsive to geopolitical risk regimes generates significantly superior risk-adjusted returns compared to static benchmarks. These findings offer valuable insights for portfolio managers and policymakers seeking to navigate sustainable fixed income markets during periods of geopolitical uncertainty. • Geopolitical risk is a net transmitter of shocks to ESG-focused bonds. • Green, climate, sustainability, and social bonds to amplify spillovers. • Blue bonds and sukuk generally act as net receivers. • ESG-focused bonds offer long-term hedging but short-term vulnerability. • Dynamic, regime-driven portfolios outperform static buy-and-hold strategies.