Brown Advisory creates ESG framework for sovereign bonds

Asset class has ‘great potential’ to achieve progress on UN SDGs but is hindered by lack of analysis

Brown Advisory has launched a framework for analysing sovereign bonds against ESG criteria, enabling it to provide clients with exposure to international sovereign debt, ESG Clarity‘s sister title Portfolio Adviser reported.

The independent global investment management firm said sovereign bonds are a relatively less developed area in sustainable fixed income, as many ESG strategies only include labelled bonds, such as ‘green’ and ‘social’.

By combining a quantitative methodology with qualitative analysis, it aims to build a holistic assessment of a country’s ESG risks and opportunities that is comparable across countries, yet able to capture subtleties and gradations.

Brown Advisory said this approach draws on its experience in fundamental analysis of corporate credit and government bonds, and is rooted in:

  • – Integration of ESG and fundamental research
  • – A focus on risks and opportunities
  • – Commitment to innovation

The ESG framework helps underpin Brown Advisory’s Global Sustainable Total Return Bond Fund, which launched earlier this month and is managed by Chris Diaz, Ryan Myerberg and Colby Stilson.

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Logie Fitzwilliams, head of international business and global head of sales at Brown Advisory, said: “More investors are seeking to incorporate ESG into investment decisions across asset classes to align their investments with sustainability goals, but sustainable approaches have remained relatively less developed in certain segments of the fixed income market. We view sovereign bonds as an asset class with great potential to achieve progress on the United Nations Sustainable Development Goals (UN SDGs).”

Ryan Myerberg, portfolio manager, Brown Advisory Global Sustainable Total Return Bond Fund, added: “One size does not fit all when assessing the sustainability profile of sovereigns. We’re excited to launch this new framework that is systematic across asset classes and geographies, but flexible enough to capture the nuances that pertain to each country and the connections across and between different ESG factors.

“The ability and reach of sovereign issuers to address key environmental and social challenges goes well beyond the scope of a corporate issuer, while sovereign ESG analysis also has the potential to reduce risk and allow us to identify compelling investment opportunities across both government and corporate bonds.”

Case study: Indonesian sovereign bond market

Indonesia’s sovereign bond market is poised to offer compelling investment performance opportunities and potential for impact. Brown Advisory’s proprietary scoring system identifies positive trends in social and governance factors that will likely continue to reinforce a constructive feedback loop in the robust macroeconomic backdrop.

Indonesia’s overarching ESG score performs in line with its emerging market peers on an absolute basis. However, examining the underlying data also provides a better understanding of the drivers of a country’s ESG performance. In the case of Indonesia, Brown Advisory notes particularly strong performance as it relates to economic opportunity (measured by employment levels, poverty reduction and amenable business environment) and education (driven by a constitutionally mandated 20% spend on education).

Moreover, Indonesia has shown positive momentum on these social indicators over the last decade, suggesting this is a trend to watch. A continually strong focus on expanding access to education in recent years may increase Indonesia’s ability to capitalise on this growing economic opportunity. This is supported by governance indicators that have also steadily improved over the last decade.

From an ESG risk perspective, investors must continue to monitor how the country is addressing physical and climate transition risk, both of which have the potential to disrupt its economy and require financial resources to be allocated to mitigation efforts. However, reduced reliance on the agricultural and forestry sectors over the last decade, in conjunction with recent announcements to phase out coal power, are positive steps and should moderate some of the environmental risks.

Moreover, the ability to build up the country’s human capital by creating greater economic opportunity and advancing education outcomes may improve its ability to transition its economy away from natural resource-intensive industries. This qualitative analysis overlay allows Brown Advisory to draw better conclusions across the ESG dimensions, which are often absent in a purely quantitative analysis of the data.

On the fundamental side, the improving economic backdrop with limited inflationary pressures and a stable currency is a compelling case for owning the sovereign bonds.

We do not expect Bank Indonesia (BI) to increase interest rates until the back half of 2022, and limited supply coupled with consistent BI purchases under the current “burden sharing” regime will likely underpin bond yields. Likewise, a positive current account and improving budget balance for Indonesia bode well for interest rates. On the technical side, the slope of the Indonesian bond curve is steep between the five- and 10-year points, which should provide an additional boost to our forecasted total returns over the upcoming 12 months.