ESG Factors in Sovereign Debt Investing

Environmental, social and governance (ESG) factors are a key aspect of the fundamental country credit analysis within the Emerging Markets Debt team at Neuberger Berman, as we view them as important determinants of the country’s potential as an investment destination.

Incorporating ESG into investment analysis also reflects our commitment to the Principles for Responsible Investment (PRI), of which Neuberger Berman is a signatory.

Our ESG model draws upon carefully selected series of research, statistical and survey data provided by international organizations, offering a comprehensive framework to complement our analysis of country-specific macroeconomic developments. ESG factors make up 40% of the Country Credit Model (CCM), our proprietary analytical tool that rates relative sovereign debt creditworthiness in emerging markets.

Application of ESG to Sovereign Debt Analysis

Our process begins by defining ESG at the country level, given that the term typically applies to company-specific performance in financial analysis.

  • The broad concept of “governance” refers both to political issues with immediate credit implications and policy issues with long-term economic and investment impact.
  • Social factors are significantly intertwined with the political/governance issues as they determine the backdrop for the decision-makers in formulating policies relating to the economy and investment. This context varies considerably among countries in terms of educational standards, poverty, illiteracy, ethnic and religious differences, and demographic factors.
  • Environmental factors are important in judging the country’s role as a responsible global actor and the efficient use of energy resources. Country adherence to environmental goals also sets the tone for the private sector.

Academic research undertaken over the past two decades has found significant relationships between ESG factors and sovereign creditworthiness. For example, a comprehensive study by Manesse and Roubini (2005)1 finds the timing of upcoming elections to be an important explanatory variable of financial crises from 1970 to 2002. The authors also find trade openness to be a key factor in hindering defaults and debt restructurings, as relatively open economies tend to lose more from economic disruptions of international trade triggered by credit events.

1Manesse, Paolo and Nouriel Roubini, 2005, “Rules of Thumb” for Sovereign Debt Crises, IMF Working Paper No. 05/42 (Washington: International Monetary Fund).

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