Peter Eerdmans

Ninety One, the global investment manager with £128.6 billion AUM (as at 30.06.24) has announced that it has launched a Sovereign Biodiversity Index^[1], which provides a quantitative way for investors to assess nature and biodiversity risks at the national level.  Today, more than half of global GDP depends on ecosystem services – the benefits that human society derives from nature^[2]. 

Peter Eerdmans, Co-Portfolio Manager, EM Sustainable Blended Debt:“As sovereign debt investors, we therefore need a practical way to assess how governments impact nature and the risks stemming from biodiversity loss, as they can significantly influence economic performance and consequently a nation’s ability to service its debt. This is particularly key for investors in emerging markets, where economies often rely heavily on nature, partly because of the relative importance of the agricultural sector.”

By assessing how governments are impacting nature and biodiversity, sovereign investors can also seek to direct capital to issuers that are doing the most to safeguard biodiversity by preserving natural capital.

The Ninety One Sovereign Biodiversity Index is the third quantitative tool introduced by Ninety One to underpin its forward-looking Environmental scores for emerging countries – part of its proprietary ESG assessment framework. It follows the 2020 launch of the Climate and Nature Sovereign Index – which assesses the long-term risks relating to climate change and nature loss at a country level – and the 2021 launch of the Net Zero Sovereign Index, which assesses countries’ progress towards net zero, within the context of a just transition.

The Ninety One Sovereign Biodiversity Index incorporates a variety high-quality data sources – nature and biodiversity is a field in which data is relatively widely available and comprehensive indices already exist. For instance, Yale’s Ecosystem Vitality index (part of Yale’s Environmental Performance Index) offers useful insights and good coverage. Ninety One incorporates this into the index, building on it to include: more data, such as the Biodiversity Intactness Index, developed by the Natural History Museum; a policy pillar, which includes progress made on relevant Sustainable Development Goals (SDGs) and environmentally aligned taxes; and a greater focus on 5-year and 10-year trends for some of the key indicators, as this provides a clearer view of near-term trends, rather than metrics based on perhaps decades of environmental change.

In summary, the index comprises three pillars:

1. Quality of Nature
2. Deforestation
3. Policy

It does not currently include a pillar on ‘risks from biodiversity loss’, given the lack of suitable data.

The results

Compiling the data together, across the three pillars, provides an overall score for each country. This can be used to rank countries, although zooming in on the details and analysing the scores of each of the subcomponents is often the most useful. The top and bottom 10 sovereign debt issuers ranked by Ninety One’s Sovereign Biodiversity Index are shown below.

Eerdmans continues: “Seven of the top 10 are European countries. This reflects stable and even improving trends in biodiversity intactness in some countries, which is counter to the global trend. Rewilding efforts and improved legal protections across the European Union have been relatively successful, as highlighted in a report^[3] co-authored by ZSL and BirdLife International in 2022.”

Venezuela is also highly ranked, scoring well on indicators of ecosystem vitality and ocean health. Deforestation has also been on a downward (i.e., positive) trend, with the latest data for 2022 showing the lowest amount of deforestation in over two decades. Some of these encouraging developments must be caveated by the fact that Venezuela has experienced an economic collapse, which has imposed high social and economic costs and caused many Venezuelans to emigrate. Nevertheless, Venezuela has long had one of the highest proportions of its territory (almost 40%) as protected areas. On the other hand, illegal mining has grown rapidly under the Maduro regime. This has led to an increase in illegal deforestation and water pollution, which might not be reflected in official data yet. This underscores the importance of conducting qualitative analysis alongside index-data assessments in the context of active investment decision-making processes.

Eerdmans concludes: “At the other end of the ranking, worryingly, the Philippines’ rich biodiversity is under serious threat from a fast-growing population and high levels of poverty, which is driving the over-exploitation of natural resources. The country is showing one of the sharpest declines in biodiversity intactness and a concerning rise in the number of species at risk of extinction. Deforestation has increased and overfishing is threatening marine biodiversity. The government has recently enacted several laws to protect the environment, such as the National Greening Program, but protected areas remain extremely small (3.7%) and woefully insufficient.”

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Notes:
[1] Sovereign Biodiversity Index
[2] PWC – Managing nature risks: From understanding to action, April 2023.
[3] https://www.rewildingeurope.com/wp-content/uploads/publications/wildlife-comeback-in-europe-2022/

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Christine joins Ninety One from Goldman Sachs Asset Management where she was Vice President, Head of Emerging Markets Local Debt, responsible for all emerging markets rates positions taken globally across their EM dedicated strategies and crossover assets.

Prior to this, Christine was an Associate at Citigroup on their Latin American Fixed Income and FX trading desk where she was a market maker of fixed income and FX products in countries including Colombia, Brazil, Chile, Peru, Uruguay and Dominican Republic. Christine has a Bachelor of Arts in Economics, and a Secondary Degree in Global Health Policy from Harvard University. Christine is currently a CFA Level II Candidate.

Peter Eerdmans, Head of Fixed Income, Ninety One: Christine brings extensive experience across the full emerging market spectrum and in particular Latin America. Furthermore, her in-depth knowledge and understanding of EM sovereign bonds, interest rate swaps, FX spot and forwards will be an asset to the team as we further develop our investment capabilities.

Christine is the second hire to the EMD team based in New York, underscoring our commitment to the North American market.

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The latest whitepaper by Ninety One ( formerly Investec Group), a global investment manager, No one left behind: Building an inclusive transition for emerging markets^[1], examines the flaws in asset managers’ and owners’ interpretations of net-zero which has led them to set portfolio-level carbon targets which will stymie global net zero ambitions.

In response to these issues, Ninety One has launched the Net Zero Sovereign Index, which provides sovereign-debt investors with a high calibre, independently verified assessment of Paris alignment.

A successful net-zero transition requires swift action and adaptations in many other areas, including regulation, consumer habits, technology and – most pertinently for investors – capital allocation. The acute risk in capital-allocation models is that emerging markets will be starved of the finance they need to transition to net-zero, in turn making it harder for the global economy to shift to a ‘decarbonised’ model. Current net-zero approaches can have major negative economic and social impacts on some of the world’s least advantaged communities, which are often the most vulnerable to the impacts of climate change. No net-zero in some parts of the world means no net-zero everywhere.

Peter Eerdmans, Head of Fixed Income, Ninety One: ‘With the UN declaring its latest climate report a “code red for humanity”, there can no longer be any doubt that we must act quickly to address climate change. The first step in tackling this problem is for investors to get better at assessing whether an investment or portfolio is aligned with a credible net-zero pathway that works for all of the world’s 7.9 billion people. As a firm that has strong roots in an emerging market, we understand this more than most’.

Emerging markets are disproportionately exposed^[2] to climate change. What is needed is a more thoughtful and forward-looking approach to net zero, one that gives due consideration to the context in which each country operates, its potential to contribute to the world’s collective net-zero ambition, and its specific transition pathway.

Net Zero Sovereign Index

The Net Zero Sovereign Index, covers 115 countries across emerging and developed markets, and is the first index which incorporates the full range of emerging markets. Building on the Climate & Nature Sovereign Index^[3] (launched in 2020), the Net Zero Sovereign Index aims to support sovereign-bond investors’ engagements with governments, so that they can hold public officials to account and encourage positive change.

Eerdmans, continues: ‘Investors need better measures to decide what is the right and fair way to build net-zero-aligned portfolios. We developed the Net Zero Sovereign Index to address the growing need among asset owners and managers for the means to show that their sovereign bond portfolios are Paris-aligned and on a credible path to net zero. We believe the index provides greater capacity to support a fair transition for emerging markets and will help sovereign-debt investors hold governments to account for their climate policies and actions.’

Initial findings
Developed and emerging markets register a divergent range of outcomes in the index.

The United States is the standout worst developed-market performer, reflecting very high emission and energy usage levels, which translate into very weak pathways scores, given the low starting point and limited progress to date. The United Kingdom and Denmark are the two strongest developed-market performers in the index.  Developed Asia generally scores poorly, with Japan in the middle of the pack and Korea and Singapore weighed down by low levels of renewables and high energy usage.

Emerging markets rank higher than many might have expected, with eight out of the top 10 countries in our index. This reflects the fact that many of these countries are embracing the energy transition and, importantly, are currently able to mobilise capital to support decarbonisation efforts, but investment must be continued and increased to ensure these efforts are sustainable. However, the index also highlights several emerging-markets stragglers which are a long way off the momentum required to achieve decarbonisation.

These countries require time, encouragement, and incentives, rather than any immediate withdrawal of capital. As such countries adopt the right approach, finance can be deployed to encourage good outcomes.

Financing an inclusive transition

Eerdmans states: ‘Asset owners need to commit capital to transition finance- both in dedicated allocations and the way they measure and monitor progress against climate goals in their core portfolios. Moreover, asset managers must develop suitable vehicles with the integrity and framework to provide comfort that committing to transition is not greenwashing.’

Creating financial instruments that help capital allocators align portfolios with a real-world, inclusive decarbonisation – i.e., instruments that channel capital to companies and projects that move the global economy closer to carbon neutrality and that enable poorer nations the opportunity to participate in the net-zero transition is imperative.

Where to focus: Electricity

Many emerging markets, including India, South Africa and Indonesia, still rely heavily on coal for electricity production, with fossil fuel accounting for 25-40% of total carbon emissions. Transport accounts for a further 9-18%. Since electric vehicles need a clean energy grid to deliver the benefit, by cutting emissions from electricity production it is possible to tackle 40-50% of total emissions in many emerging markets.

Four major funding streams need to be developed to clean up electricity generation in the developing world:

1. available capital must be scaled up for renewable energy roll-out
2. sizeable investment needs to be directed towards expanding transmission infrastructure
3. incentives for state utilities to accelerate the closure of high-emitting plants
4. funding for a fair transition for employees and communities at risk from removing reliance on fossil fuels.

Eerdmans concludes: ‘Time is indeed short, and asset owners and managers cannot delay. But we must also be certain that our first steps are in the right direction. The race to net zero is not a race between countries. It is a race against time.’

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[1] No one left behind: Building an inclusive transition for emerging markets
[2] Ibid
[3] Climate & Nature Sovereign Index
[4] No one left behind: Building an inclusive transition for emerging markets

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The attached paper^[1] covers the market background highlighting “The paring back of monetary policy support, coupled with inflation concerns, weighed on sentiment.  Most EM currencies weakened vs. the US dollar, given the risk-off sentiment shift.”

Peter Eerdmans, Head of Fixed Income and Co-Head of Emerging Market Sovereign & FX, says: “Inflation concerns remain front of mind for investors, dampening optimism around the growth recovery story.  With various data prints still pointing to rising headline inflation, the view that this is a largely temporary phenomenon is being challenged globally.

“By purely focussing on the effects of higher inflation, investors risk missing the broader cyclical picture, which remains attractive across EMs, especially against the backdrop of a global energy transition and the associated infrastructure spending that it will entail.  While there will certainly be supply bottlenecks with accompanying surges in inflation as economies recover, most of these should prove transitory, if history is any guide.

“The recent reinflationary pressure should be viewed against the much longer disinflationary trend of the last 25 years.

“Investors should also note that the scaling back of support measures – likely to start in the coming months – will take place before the Fed considers raising rates.

“The revival in goods demand and impact on global manufacturing continues to be supportive for EM.

“The US$1.9 trillion stimulus package and improvements in how governments, firms and society deal with COVID will also have a positive impact on demand. While the reintroduction of lockdown measures in parts of the world could weigh on the services sector, particularly travel, higher immunity levels (natural and vaccination-derived) should ensure the effect is modest.

“We expect the recovery in activity from the low levels recorded last year to push EM growth rates ex-China higher in the latter part of the year, despite some fiscal drag as spending normalises after the pandemic-related surge. We continue to believe global central banks, and particularly those in DM, will generally remain supportive of economic growth and that the risk of an abrupt shift away from loose monetary policy that threatens the global recovery remains low.

“The more predictable policy backdrop of the US administration under President Biden is also expected to be modestly supportive for EMs. We think these macro and geopolitical adjustments are likely to be accompanied by a high degree of divergence for sovereign debt, reflecting factors such as countries’ vulnerabilities at the start of the crisis (which may have been exacerbated by the pandemic), how well governments have handled the crisis, and – crucially – how they will finance and reduce their deficits.

“ With a significant proportion of Developed Markets sovereign debt still in negative real yield, we expect investors to reassess allocations to EM debt, as its yield and relative-value attractions remain intact. As well as the allure of relatively attractive yields, supportive tailwinds include strong commodity prices and historically high terms of trade, with EM (ex-China) growth projected to accelerate in the second half of the year, despite the modest fiscal drag.

“We remain moderately constructive on prospects for the EM debt asset class and through recent months have kept a small risk-on top-down target across our strategies. While we continue to see longer-term value in EM FX, we are more cautious on a tactical basis, given the more mixed short-term dynamics.

“On local currency bonds we are more constructive and modestly overweight some of the markets with steep yield curves, especially when considering the relatively high amount of central bank tightening priced in across many emerging markets. While we continue to see value in EM hard currency high-yield bonds with spreads still wide to pre-COVID levels, we have modestly reduced our overall overweight in hard currency debt.”

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[1] Emerging Market Debt Indicator, September, 2021

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