Candriam excludes 40 percent of all emerging markets

An emerging market bond fund with the best performance versus its peer group avoids Russia, China, and Saudi Arabia, Bloomberg reported. In the opinion of Candriam’s fund management, the ESG ratings of these countries, i.e. the assessment of the factors environment, social and governance, are not sufficient to include them in the Candriam SRI Bond Emerging Markets Fund.

According to Bloomberg, the Candriam SRI Bond Emerging Markets Fund, with a market capitalization of $1.5 billion, has outperformed almost 90 percent of its competitors over the past three years: In 2019, its performance was 16 percent. While the loss in value in the first quarter of 2020 was -9.6 percent, the fund turned positive in the second quarter with 10.1 percent and achieved a further growth of 2.0 percent in the third quarter.

The fund, launched in November 2016, aims to enable investors to benefit from the performance of bonds and other debt instruments, mainly denominated in developed currencies such as the US dollar, euro, pound sterling, Japanese yen and in addition local currencies, issued by public and private sector issuers in emerging markets. In order to outperform the Fund’s benchmark indices, government and corporate bonds are selected at the discretion of the portfolio management team based on security characteristics, growth prospects and internal analysis of ESG criteria. Candriam’s management blacklists the worst performing 25 percent of countries from the entire investment universe, regardless of their role in the bond world.

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The pricing of government bonds has so far left ESG criteria out

This approach gives a first impression of the new challenges that emerging markets whose governments and companies are dependent on foreign capital are likely to face. At present, the cost of borrowing in this group of countries generally does not take into account factors such as the commitment to reduce carbon emissions or curb corruption. However, these factors could play an important role in the future.

“ESG investment is becoming increasingly important in the context of emerging market bonds,” observed Magda Branet, Emerging Markets Bond Strategist at Candriam, “and it is likely that investors will become increasingly concerned about the extent to which they are compensated for ESG risks in emerging markets. They will demand higher risk premiums from countries that perform poorly on the criteria or avoid some issuers altogether,” Branet predicted.

33 emerging markets are considered non-investable for Candriam

Valuation models developed by Candriam examine how countries use their raw materials, resources and human capital. Countries that are considered undemocratic or repressive are blacklisted, as are countries and companies with a credit rating below B or six levels below investment grade.

“Currently, the model excludes 33 emerging markets, or about 40 percent of the JPMorgan EMBI Global Diversified Index, which is the benchmark for most emerging market sovereign bond funds,” Branet said. Candriam, a subsidiary of New York Life, one of the world’s largest asset managers with more than €500 billion in assets under management, regularly reviews the countries using its proprietary model, so that emerging markets and companies that have been poorly rated up to now are given the chance to join the group of investable countries and companies, provided they introduce improvements.

The fund’s largest country holdings include government bonds from Mexico, Uruguay, Serbia, Hungary, Uruguay and Namibia. The chemical group Sociedad Química y Minera de Chile (1.67 percent of the fund volume) and the Export-Import Bank of India (1.66 percent) also made it into the top 10. 

“An improved willingness to perform in the area of ESG strategies, especially in the environmental sector, can help a country make the leap onto the investment list,” promises Branet, pointing out that there are currently no standards for the application of ESG to government bonds. Therefore, most fund managers who want to include ESG would have to resort to internal analysis. However, Branet observes that, unlike Candriam, very few funds ultimately exclude large emerging markets on the basis of low scores.

Inflow of funds becomes a means of pressure

According to the Bloomberg report, Bram Bos, senior portfolio manager at NN Investment Partners, also confirmed changing investor needs and demands on emerging markets and emerging market companies. He said it is likely that the adoption of ESG criteria in emerging markets will have a positive impact on the cost of borrowing. Governments and companies that issue bonds that take environmental and social considerations into account will find it much easier to attract capital than countries and companies that neglect them. As emissions have already reached record highs this year, players in the emerging market universe can already see where the journey will take them: Improvements in ESG ranking will pay off.

“In the past, a government used to invite people to roadshows when it wanted to issue a bond, and it was all about macroeconomic fundamentals,” says Bos. “Nowadays, green and social bonds are being used to discuss other issues, and this gives investors another tool to put pressure on governments.

For investors who want returns based on ESG criteria while being diversified in emerging markets, funds like the Candriam SRI Bond Emerging Markets Fund offer an alternative to simply selecting bonds and stocks available from the emerging markets universe. The help of experienced fund managers should not be inconvenient, especially in the current difficult and confusing market situation: In view of the pandemic that continues to affect a large part of the world, the question for investors is which countries and which companies will emerge from the crisis with the least losses, or will even come out stronger than ever through targeted strategic adjustments.

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(Featured image by JuergenPM via Pixabay)

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