AXA Investment Managers (AXA IM) has developed a framework for analysing countries' sovereign debt according to environmental, social and governance (ESG) criteria.
AXA Investment Managers (AXA IM) has developed a framework for analysing countries’ sovereign debt according to environmental, social and governance (ESG) criteria.
Matt Christensen, Global Head of Responsible Investment for AXA IM, said there is increasing interest from clients in ESG analysis that can be applied to asset classes such as sovereign debt, partly driven by the eurozone crisis and fresh analysis of sovereign issuers’ creditworthiness.
A research paper by AXA IM’s Responsible Investment team, ‘Sovereign debt investing: ESG framework and applications’ outlines two ways that investors can draw upon ESG analysis for their sovereign debt portfolios. The first addresses investors’ desire to limit reputational risk by screening the investment universe using specific ESG criteria before the portfolio construction phase.
“One of our clients asked AXA IM to minimise the reputational risk of their existing emerging markets sovereign portfolio holdings,” explained Christiansen. “The rules-based reputational screen identified 10 (from a total of 57) sovereign issuers that presented significant reputational risk – representing 9.7% of the universe’s market capitalisation.”
He noted that the move to rules-based screening did not significantly alter the quality, yield and duration characteristics of the portfolio. In terms of credit quality, the risk screen reduced the percentage of highly speculative debts and this quality improvement was without significant impact to the yield and duration.
“A key issue for investors is the long-term sustainability of a country’s economic and political situation and therefore addressing ESG issues naturally aligns with this,” he added. “In addition, many institutional investors wish to limit reputational or headline risk in order to avoid negative perceptions associated with a particular activity or regime. Investors may find a reputational risk strategy based on negative screening particularly useful for emerging markets since these countries tend to score poorly on governance measures such as control of corruption relative to developed markets.”
Secondly, the research examined how an ESG overlay would impact a sovereign debt portfolio’s key characteristics. The study showed that an ESG overlay within defined risk parameters does affect country allocation and can improve the ESG performance of a sovereign debt portfolio whilst having a limited impact on other key portfolio characteristics including quality and duration.
The top ESG overweights for emerging markets were Poland and Chile. For developed markets, Spain topped the list for its better than average ESG score, despite a poor S&P long-term rating and gloomy economic prospects. The top ESG underweights for emerging markets were the Philippines, Columbia and Indonesia.
For developed markets, Japan was the largest underweight largely due to governance issues, while sovereigns with high quality long-term ratings such as the United Kingdom and the United States were slightly underweight largely as a result of poor environmental indicators.
“We have seen that ESG factors may be becoming more material to sovereign debt investing and that investors are taking note. In response, AXA IM has begun to examine the different ways in which ESG criteria can be applied to sovereign debt portfolios. We are already using this ESG country framework in our core RI funds, but see an opportunity to expand this into our mainstream funds. The strength of our model is its flexibility, which allows us to propose different ways to integrate ESG criteria according to a fund’s specific objectives and the client’s requirements.”