The PRI has published a new discussion paper exploring the relationship between ESG factors, sovereign credit risks and investment performance. It aims to prompt institutional investors to take a more holistic view of credit risks in their sovereign bond portfolios by considering ESG factors in their investment processes.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. The 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.
A copy of the paper can be downloaded from the Publications page.