ESG: Putting Sovereign Debt Under the Microscope

(February 11, 2013) — First equities were in the spotlight, now investors are increasingly concerned with the environmental, social and governance (ESG) factors inherent in sovereign debt holdings, a fund manager has claimed.

Axa Investment Managers (Axa IM) has created a process to identify the risks posed by ESG factors inherent in sovereign debt investments, the firm announced today.

The fund management firm said the framework would analyse countries according to ESG criteria and offer ways of applying these measures to sovereign debt portfolios.

Matt Christensen, global head of responsible investment at Axa IM, said: “We are seeing increasing interest from clients in ESG analysis that can be applied to asset classes such as sovereign debt. The Eurozone crisis has only amplified this interest as the evaluation of sovereign issuers’ creditworthiness has been brought to the fore.”

Some of the largest pension funds in the world have upped their interest in the ESG characteristics of their portfolio. Last month, the California Public Employees’ Retirement System unfolded a sustainable investment research initiative to help pension funds understand the impact of sustainability factors on financial performance.

Axa IM’s first screen allows investors to limit reputational risk by screening potential investments using ESG criteria before accepting it to a portfolio. Axa IM said 9.7% of the market capitalisation of sovereign issuers presented reputational risk to investors and removing this from portfolios did not alter the quality, yield or duration of the portfolio. It increased the credit quality of the portfolio by removing speculative debt, however.

“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” said Christensen.

The framework also affects country-weighting in a portfolio, Axa IM’s research found, as ESG was measured differently to other types of risk.

The United Kingdom and United States, while being some of the strongest in terms of creditworthiness, were underweighted in one of Axa IM’s model portfolio due to poor environmental indicators. Spain, Poland, and Chile were better regarded due to better ESG records.

Christensen said the model could be used flexibly according to client’s requirements and objectives.

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