9.2. Optimised Geographical Asset Allocation Thanks to ESG Integration

9.2. Optimised Geographical Asset

Allocation Thanks to ESG Integration

Philipp Mettler, CFA Senior Sustainable Investment Analyst, J. Safra Sarasin

The integration of ESG factors into asset management is steadily growing. Even so, it is not yet possible to claim that “non-financial” aspects are systematically and consistently integrated throughout the entire investment process. 1 While greater attention is being paid to ESG criteria when selecting individual securities—whether equities or bonds—this does not generally appear to be the case when it comes to the geographical allocation of funds. It is precisely here that the integration of ESG components provides an opportunity to make a sustained improvement to a portfolio’s risk/return profile.

In general, there are two ways of optimising the geographical allocation with the help of ESG data: 1. 2.

The aggregation of relevant ESG company ratings on a country basis

The use of top-down sustainability ratings of countries 2

With the first approach, good company sustainability credentials lead to positive country ratings. The second approach is a top-down country analysis that considers ESG factors and therewith brings valuable aspects for achieving financial outperformance into play. Various studies 3 show that such factors as minimal corruption, stable political governance, and strong innovation certainly have an impact on a country’s development over the longer term. This is why ESG country ratings often contain indicators on the overall conditions in a country, such as legal certainty, political governance, population structure, and human capital—factors that are by nature relevant for companies. The historical trend in sustainability is thereby just as relevant as a country’s current performance (see Figure 7).

The reasons for the positive trends in Eastern Europe and Central Asia, and also in Africa (including the sub-Sahara zone), are partly due to the low baseline but also due to structural advances. By contrast, some countries in Central and South America, as well as in the Middle East, struggle to create a suitable environment for sustainable development. Here it should be remembered that the rate of change in emerging/frontier markets is much higher than in developed markets.

Figure 7. Sustainability Trend Data over Five Years (indexed)

108 106 104 102 100 98 96 94 92 90 2012 2013 2014 2015

Central and South America

Eastern Europe and Central Asia North America Middle East 2016 2017

Africa Asia and Oceania

Western Europe

Source: J. Safra Sarasin (2017).

To summarise, ESG country ratings applied to strategic asset allocation can potentially improve a portfolio’s risk/return profile. Furthermore, ESG trends can be an indication of structural changes in emerging and frontier markets, especially.

Endnotes

1 Novethic. (2015). Profile of responsible investors in Europe. Available at: http://www.novethic. com/fileadmin/user_upload/tx_ausynovethicetudes/pdf_complets/2015_responsible_investors_survey.pdf. 2 Primarily to complement credit ratings, where the emphasis is clearly on financial aspects. 3 Hoepner, A. G., & Neher, A. L. (2013). Sovereign debt and sustainable development culture. Available under SSRN 2295688.