Morgan Stanley IM: ESG in Sovereign Fixed Income Investing - Identifying Opportunities, Correcting Biases

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In 2019, we published our Morgan Stanley Investment Management (MSIM) Fixed Income “ESG and Sovereign Fixed Income Investing: A Better Way” approach. We highlighted our thesis that countries’ sustainability performance should be evaluated in the context of their stage of development. Our methodology allowed us to avoid the systematic bias against developing countries that typically have lower absolute sustainability performance compared to more developed countries, but may well be outperforming relative to what might be expected given their GDP per capita. In our updated methodology, we introduce further enhancements to our approach, incorporating a broader range of independent Environmental, Social and Governance (ESG) data, a comprehensive assessment of sustainability momentum, flexibility to adapt the approach depending on timeframe, and an impact framework based on the UN Sustainable Development Goals (SDGs).

We introduce our newly enhanced Sovereign Sustainability Model (Display 1), a significantly updated and comprehensive approach to evaluating ESG performance for Sovereign issuers, which is designed to enhance and inform our investment process. Our model integrates the following key elements:

1. A materiality-based selection of ESG factors, seeking to capture metrics pertaining to a country’s usage of natural resources and climate change vulnerability, human development, the quality of institutions, and rule of law across developed and emerging markets.
2. Adjustments of our E, S, G scores by GDP per capita to help remove bias against emerging markets. By adjusting against GDP per capita, we believe we can control for wealth and rank of each country based on their expected performance on ESG metrics relative to their income.
3. Incorporation of a momentum factor that combines our analysts’ qualitative view with a quantitative assessment of track record.
4. Embedded flexibility to change the weights applied to E, S and G factors, acknowledging that the relative importance of these factors may vary depending on the time horizon of the debt instrument.
5. Classification of countries in our data set into five categories based on our assessment scale, from “Significant ESG Outperformer” to “Significant ESG Underperformer.”
6. Adoption of the SDGs as the reference framework for interpreting countries’ progress on economic and social development.

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