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ESG in Practice series: Mary-Therese Barton on engaging with emerging market sovereign borrowers
Talking about issues such as education or healthcare with governments is part of our fiduciary duty - and helps us form a holistic view of the countries we invest in, says head of emerging market debt Mary-Therese Barton.
Written by
Mary-Therese Barton
Chief Investment Officer Fixed Income
Sovereign engagement is a theme that has gained in importance with emerging market investors. Could you tell us more about it?
In the investor community, there is a greater recognition that environmental, social and governance (ESG) issues are material to the long-term development of emerging markets. In our team, we see it as part of our fiduciary duty to engage on these topics with sovereign issuers – it allows us to make better informed investment decisions while helping enhance returns over the long-term. And if the whole industry continues to focus more time and attention on this, we could really start to move the needle.
At the same time, sovereign issuers are now dedicating resources to and opening dialogue on matters of ESG concern. We meet with governments regularly and use this as an opportunity to discuss areas that our research has highlighted. For example, in South Africa, we have discussed the protection of education in the context of spending cuts and the importance of improving educational outcomes.
How does engagement with sovereigns work?
Engagement with a sovereign nation is particularly challenging, mainly because it is hard to work out how to apply pressure effectively. Unlike those asset classes where shareholders can use their voting rights to protect their interests and challenge corporate management, we as sovereign bond investors cannot vote. Moreover, sovereign investor engagement can be misinterpreted as lobbying, advocacy or an attempt to interfere in governments’ policy choices.
Despite these challenges, we actively seek to engage with sovereign issuers usually via their debt management officers and/or treasuries. We firmly believe we can help drive change to advance countries’ sustainability agendas. To increase and amplify our influence, we sometimes partner with other investors when engaging. For example we have joined the Emerging Market Investor Alliance (EMIA), collaborating with other institutional investors to carry out joint initiatives and share engagement ideas. We are the lead on an engagement with Colombia where we have offered guidance for the issuance of ESG-labelled bonds.
How do you factor in the social element in your investments?
Social issues are hugely relevant to how we understand emerging markets, even more so in a post-Covid landscape. Poverty levels have been set back decades by the pandemic. We believe that social issues – such as healthcare, education, judicial independence or corruption – are key to long-term structural development in emerging markets. They are the areas that need funding the most.
However a lot of governments in the developing world are now being subjected to very strict environmental targets so there's probably going to be a shift in emphasis to the green space. We’ve already seen a heavy focus on green bond issuance. It’s where we see the most demand from clients, and governments have responded to that.
EMpower - The Emerging Markets Foundation
The key to properly factor social issues in our investment process is research in areas of focus. We've built a partnership with EMpower, an organisation that works on empowering women and marginalised at-risk youth in emerging markets through education, employment and social projects. Our relationship with EMpower arms us with research that we wouldn't be getting elsewhere. We meet with their programme managers and explore their projects to really understand the issues. This helps us complete our understanding of the future trajectory of these countries. Combined with our in-depth research and scoring methodology, we can assess risks, but also increasingly build ESG-focused strategies.
In the past 18 months, we met with programme managers and organisations in Brazil, Argentina and Colombia and that gave us great insight to the challenges they face in terms of education and social exclusion, problems which have unfortunately worsened in the wake of a credit crisis.
We bring these insights to the table when we meet with members of finance or labour ministries. We show that we take our role as investors seriously, with a focus on positive long-term outcomes.
Where do you see the growth of sustainable sovereign investment?
Even in the current volatile market context, and with sovereign issuance at record lows, we have seen robust activity in the ESG bond space, particularly for green bonds. To me this represents a structural shift in how emerging market (EM) governments are coming to market.
Green bonds are not perfect but they are an important first step in terms of improving transparency and creating multilateral relationships with asset managers, banks and agencies such as the UN or the World Bank to maximise impact. That collaboration for me is going to be the game changer.
Contrary to what one might think, emerging markets are not trend followers when it comes to green and other ESG-labelled bonds. This financing is so important for them that they are leading innovation. For example, EM countries issued a total of USD81.9 billion of ESG-labelled bonds in the first half of 2022, an increase of 2 per cent compared to the same period of 2021.1 Chile has even decided to only issue social and green bonds, no plain vanilla bonds.
I am encouraged to see investment banks are now creating development finance institutes within their issuance desks. They increasingly include impact measures even when issuing conventional paper.
ESG-labelled sovereign bonds create an alignment between investors and the sustainable economic development of emerging economies. Importantly, the transparency and accountability demanded by ESG-labelled bonds provides a robust framework for engagement – ultimately enabling investors like us to have a more active and structured dialogue with sovereigns on social and green outcomes. Countries tend to be quite thorough in how they explain the objectives and that gives us a better view of the policy and reform priorities. All of this gives us the opportunity to invest responsibly and with impact.
However, for the asset class to become truly mainstream, we need better alignment with rating agencies, investment consultants and data providers.
We see it as part of our fiduciary duty to engage on ESG issues with sovereign issuers
What’s the impact on returns?
We get asked that question a lot: does investing in ESG-labelled bonds mean taking a yield hit?
ESG-labelled bonds tend to be issued at a slightly lower premium. This is something we weigh in our investment process. If we think the long-term structural benefits of these bonds are strong, then we will be happy to take that slightly lower premium, because we are talking about a marginal hit given the percentage of the portfolio we are looking at. But ultimately, our belief is that we can add value to the portfolio through our issue selection, and our performance numbers speak for themselves.
You also have to consider how much we save through our ESG views. If we take the example of Russia, our move to an underweight position in the sovereign debt prior to the invasion was based on an ESG rationale – if you had not had that rationale, you’d likely have held more exposure to Russia.
We think our ESG views create the basis for very interesting discussions with clients and they value our long-term approach.
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