PRI paper highlights the materiality of ESG factors in the $47 trillion sovereign debt market

LONDON, 12 September 2013

The Principles for Responsible Investment (PRI) Initiative today published a discussion paper exploring the link between environmental, social and governance (ESG) factors and credit risk in the $47 trillion sovereign debt market to help signatories better understand the risks associated with this asset class and the implications these factors may have for the performance of their portfolios. The paper was written with input from the PRI’s Sovereign Fixed Income Working Group, made up of representatives from 33 global pension funds, investment managers and other signatories to the PRI.

This group was formed in 2011 to explore the use of ESG analysis as a potential risk-reducing, return-enhancing tool when added to the traditional mix of financial and economic data and political risk when assessing sovereign creditworthiness. The analysis and experience of the group is reflected in the paper, which draws on academic and industry research to highlight how different ESG factors correlate with bond yields, credit ratings and, ultimately, investment performance. It also explores why the market is failing to factor in major ESG risks despite mounting evidence of their materiality.

Among the paper’s key findings:

ESG analysis provides investors with additional insight into sovereign credit risk, with multiple studies confirming correlations between ESG factors and credit risk.

ESG factors have proved to be material to sovereign creditworthiness and investment performance, with research suggesting sovereign debt issued by countries with higher ESG scores outperformed over the euro crisis period.

Investors want credit rating agencies to use ESG analysis to inform their sovereign debt ratings in a more systematic way, taking into account quantitative and qualitative criteria.

“While ESG analysis has been applied increasingly to equities, few have put it to the test in fixed income until now,” said James Gifford, Executive Director of the PRI. “Stung by market volatility during the euro crisis, institutional investors are now applying ESG analysis to their sovereign bond portfolios and using it in their selection criteria to appoint asset managers. Given the sheer size of the sovereign bond market and compelling evidence that these factors are material to both creditworthiness and investment performance, the challenge is now on others to act.”

“ESG factors influence the economic development of countries. They also played a role in the current sovereign debt crisis,” said Florian Sommer, Senior Strategist at Union Investment and Chair of the PRI’s Sovereign Fixed Income Working Group. “Investment research today still largely fails to make the link between ESG and credit risk, despite growing evidence to the contrary. This working paper seeks to change this by putting the spotlight on sovereign ESG risks.”

Note to editors:

The paper was prepared by the PRI with input from representatives from the following organisations who are members of the PRI’s Sovereign Fixed Income Working Group:  AEGON Asset Management, AllianceBernstein, Allianz Global Investors, Allianz, ASR Nederland, ATP, AXA Investment Managers, Bank J. Safra Sarasin, Bloomberg, BlueBay Asset Management, Breckinridge Capital Advisors, Danske Bank, Deutsche Bank Advisors, Generation Investment Management, Global Evolution, Hermes Fund Managers, HSBC Global Asset Management, Maplecroft, MN, MSCI, oekom research, Pension Protection Fund, PIMCO, Skandinaviska Enskilda Banken (SEB), SNS Asset Management, Stichting Philips Pensioenfonds, Sustainalytics, Trucost, UNEP Finance Initiative, Union Investment, Unipension Fondsmaeglerselskab, University of St. Andrews and Vigeo.

A copy of the paper can be downloaded from the PRI website.

For more information, contact:

Matthew McAdam
Head of Communications, PRI
+44 (0) 207 749 5141