Research that looks at the relationship between economic transparency and defining investment qualities such as yield spreads, credit ratings and stock price volatility shows sovereign transparency helps improve the value of assets, enables countries to lower their borrowing costs and achieve a better credit rating.
Sovereign transparency helps improve the value of assets, enables countries to lower their borrowing costs and achieve a better credit rating. Speaking at FIS Digital 2021, Marshall Stocker, director of country research, emerging markets at Eaton Vance Management in Boston, explained how the firm’s proprietary index which tracks sovereign transparency in 130 countries has become a valuable investment lens. The discount rate on assets shrinks as transparency improves resulting in assets going up in value, he said.
The index is compiled by rating the availability of a sovereign’s economic data on an annual basis. Key points include if economic data is published in English and how regularly it is updated.
“We find that countries prepare documents in their local language but not in English,” Stocker said, adding that the Eaton Vance index also differs from others in the market given it looks at all available monetary, fiscal and economic data.
Stocker added that economic development and transparency are linked, making transparency crucial for emerging markets. Moreover, the index illustrates that wealthy countries are also the most transparent and he added that contrary to common perceptions, transparency does not create more volatility for investors.
China sits in the the bottom half of countries when it comes to economic transparency. Stocker also told delegates that higher levels of sovereign transparency don’t necessarily increase levels of trust in a government. Elsewhere, he noted that some countries (like Ukraine) have relatively high levels of transparency, but struggle to subsequently enforce rules and laws to deal with the challenges transparency reveals.
Stocker said that asset owners have an important role in engaging sovereign governments on transparency, describing a process whereby Eaton Vance holds sovereign level discussions comparable to investors at a corporate level. The firm shows up at the table with evidence to prove that changes in governance are good for countries.
Majdi Chammas, head of external asset management at AP1, explained how Sweden’s $45 billion buffer fund is integrating transparency into its emerging market passive exposure. The fund uses a corporate scoring process whereby greater transparency increases a company’s weighting in the index. Launched with one of the fund’s emerging market managers, transparency is one of the key pillars in the strategy.
Engagement around transparency is particularly important, says Chammas. Strategy involves engaging with corporates that have a low level of disclosure.
“If the level of disclosure is low, the first thing we do is engage,” he says. In many cases, companies have the data but are often not aware of it. Moreover, although information might not be disclosed by companies or is hard to access, huge amounts of data exists and information can be gleaned from unstructured data and social media. For example, employee discussions can feed into valuable ESG insights.
It led to Chammas reflecting on the challenge of integrating ESG into passive portfolios that own all companies in an index. Through this strategy, AP1 has created a portfolio that has all the hallmarks of passive given its liquidity, systematic characteristics and ability to capture equity premia. He also touched on API’s obligation to be a role model globally, hence the fund opening up and sharing its solutions with other investors.
Fossil fuel exclusion
Elsewhere, AP1 has begun excluding fossil fuels from its entire exposure.
“We thought it would be tough to exclude such a big part of the portfolio, but we’ve had real success,” Chammas told delegates. Although excluding fossil fuel groups in segregated mandates wasn’t too challenging, the process was more problematic in AP1’s fund exposure and has resulted in the investor launching some new funds and strategies with managers.Recalling the drive behind the strategy change, he said it was based on AP1’s climate and scenario analysis and the financial risk posed from fossil fuel groups.
Chammas concluded that exclusion is only one part of the AP1’s strategy. Engagement and dialogue and an active approach, particularly in China, is just as crucial.
Stocker concluded that emerging markets do face challenges around access to data and poor policy. But by engaging and trying to improve the situation will lead to change. It involves fundamental understanding of the challenges in each country, he concluded.
