ESG factors at the forefront
Increasingly, investors are concerned about the impact their investments
have on the world around them. The
MSCI ESG Fund Metrics
provide fund-level ESG (environmental, social, and governance)
characteristics based on MSCI ESG ratings of the underlying holdings. The
Fund ESG Quality Score is an overall score that summarizes underlying ESG
factors for ease of comparison among peers. The underlying factors include
exposure to carbon intensive activities, Sustainable Impact Solutions, SRI
Exclusion Criteria, and exposure to the best and worst ESG companies (ESG
There is no doubt that Canada is a mature Responsible Investment market
where investors would be forgiven for sticking to any number of homegrown
funds with exemplary ESG Quality Scores. But the truth is that some of the
biggest challenges facing us today lie in Emerging Markets. This includes
the new category, Emerging Markets Fixed Income. It is here that FundGrade
RBC Emerging Markets Bond Fund
vies for the top spot. This fund is no stranger to the FundGrade A+ Awards,
having won in its category in 2015, 2016, and 2017. It is on pace to
winning its fourth consecutive A+ Award in 2018.
Between a rock and hard place
Many countries that are typically referred to as Emerging Markets may not
at first appear as if they belong in the RI investor’s portfolio. However,
it is in these markets that one finds the greatest need for engagement and,
in turn, where investment can have the most impact.
RBC Emerging Markets Bond Fund sits at the 10th percentile in
the MSCI global ranking, well below the global average. It may seem strange
to highlight what seems to be a negative attribute, but it turns out that
it is noticeably average in the Emerging Markets Fixed Income category.
This highlights one of the challenges of RI investing, and Emerging Markets
RI in particular, which is that every decision involves a tradeoff. As an
RI investor with limited resources, it is simply not possible to engage
with every issue. There is no perfect company, no perfect investment, and
no perfect fund. Nowhere is that more apparent than in Emerging Markets.
As with the FundGrade A+ Awards, the overall ESG Quality Score is valuable
as a standalone comparative, but for true insight into the into responsible
investment impact of a fund, a look at the individual factors and portfolio
is necessary. Graph 1 compares the 12-month average MSCI ESG Fund Metrics
for RBC Emerging Markets Bond Fund with the Emerging Markets Fixed Income
category and global averages for 2018.
When breaking down the score of RBC Emerging Markets Bond Fund, a picture
of the factors contributing to a low ESG Quality Score emerges and explains
why it should not necessarily preclude an investment in a specific country
or region. One of the primary negative contributors to the overall ESG rank
is a high Carbon Intensity score. In fact, it is four times as high on
average as the overall category, and over seven times globally. The most
recent portfolio report shows that the fund is heavily invested in foreign
government bonds as shown in Graph 2.
That explains the high Carbon Intensity score, because governments are
often involved in large-scale infrastructure and resource development
projects. Due to the nature of these activities, they are generally
equipment and labour intensive, which leads to a larger carbon footprint.
Furthermore, projects involving the extraction and depletion of
non-renewable natural resources are by definition low in terms of
sustainability, which explains the fund’s low Sustainability Impact rating.
There are also positive impacts that are affected through the financing of
foreign governments. The RBC fund is in the top 10% of funds with the
lowest exposure to SRI Exclusion Criteria, which includes weapons, tobacco,
and alcohol production. Increased exposure to ESG Leaders and reduced
exposure to Laggards is another important consideration. While RBC Emerging
Markets Bond Fund does not have significant exposure to any ESG Leaders,
its exposure to ESG Laggards is low. It is apparent that when investing in
Emerging Markets governments, there are inherent positive and negative
Room for improvement
In Responsible Investing, it always pays to analyze the ESG factors in
detail because there are tradeoffs to every choice. This is true even in
Canada, a well-established ESG leader. Canada has one glaring
inconsistency: relatively high levels of natural resource extraction, in
particular oil and gas. Although RBC Emerging Markets Bond Fund has a
Carbon Intensity score in the bottom 10%, it is not actually the worst.
That distinction goes to a fund with a Carbon Intensity rating over three
times higher. Who is the “culprit”?
Well, the offending fund invests almost entirely in Canadian government
bonds. One may then be surprised to learn that the fund has an overall ESG
Quality Score in the 99th percentile; placing it in the top five of all
MSCI ESG-rated funds in the Fundata universe. Despite its large carbon
footprint, Canada and the Canadian government are still global ESG leaders,
promoting diversity, social equality, and transparency around the world.
Challenging investment environments like those found in Emerging Markets
force investors to choose what type of impact they want to have as if they
have a focus on responsible investing. Such investors can confidently
approach RI investment decisions and understand their effect on the
environment by using a combination of Fundata FundGrades and MSCI ESG Fund
Metrics to target specific ESG factors among the best-performing funds.
John Krisko, CFA, BBA,
is Manager, Analytics & Data, at Fundata Canada Inc., a leading
source for investment fund information. He is also Vice-Chair of the
Canadian Investment Funds Standards Committee (CIFSC).
Notes and Disclaimers
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