political risk, esg and market performance - march 2014
DESCRIPTION
As the ASX releases new corporate governance guidelines with an increased focus on risk management and environmental, social and governance principles Political Monitor examines the link between ESG, political risk & market performance.TRANSCRIPT
www.politicalmonitor.com.au!
Poli%cal risk, ESG & market performance Going beyond economic analysis to meet responsible investment principles
OVERVIEW!The United Nations Principles for Responsible Investment (PRI) have transformed the way institutional investors and listed entities think about governance and sustainable investment. This has added impetus to the search for new risk models that take account of factors not traditionally monitored in credit and equities analysis, including social and political trends that may alert investors to systemic risk.!
The challenge has been establishing a clear link between responsible investment and performance outcomes and developing tools that quantify environmental, social and governance (ESG) risks. This pack addresses this challenge by examining recent findings on the link between governance and performance and then detailing the tools developed by Political Monitor - a political risk research & advisory firm - to identify, score and report on political risk in key markets.!
The pack provides summary analysis and more detail is available by contacting:!
!Damian Karmelich ! ! ! ! ! ! !Steve Cusworth!Partner – Sydney ! ! ! ! ! ! !Partner - Melbourne!p. 0407 772 548 ! ! ! ! ! ! ! !p. 0417 178 697!e. [email protected],au ! ! ! !e. [email protected] !
CONTENTS!• Executive summary …………………………………………………………………………. p. 4!
• The relationship between governance, risk & performance ..…………………………… p. 5!
• Country risk ……………….…… ………………….………..… ……...….……... p. 6!
• Company & market risk ……………………..………… …………..…….……... p. 8!
• Political Monitor methodology …………………………..…………….….……………...… p. 9!
• Country risk ……………………………………………………………………….. p. 11!
• In-country risk …………………………………………………………………….. p. 12!
• Sector & firm risk …………………………………………………………………..p. 13!
• Political Monitor risk scores, ESG and ISO standards ……………………….. p. 14!
• Enough theory: how does it work? ……………………………….……………...………… p. 15!
• Appendix 1 - Economic & investment impact of political and social instability …….….. p. 21!
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Political risk, ESG & market performance! 3!
EXECUTIVE SUMMARY!
Political risk, ESG & market performance! 4!
• There is now clear evidence of the link between responsible investment and performance outcomes.
• Recent research by the PRI Sovereign Fixed Income Working Group revealed correla%ons between ESG factors and credit risks. Those factors include corrup%on, poverty, unemployment rates, food security and popula%on distribu%on.
• However, quan%fying ESG risks has been a challenge
with many investors struggling to measure such risks and include this data in risk models.
• Poli%cal Monitor has overcome this challenge by developing a number of poli%cal risk scores that consider and quan%fy a range of social and governance issues providing insight into underlying social and poli%cal trends likely to shape markets.
• One example of the benefits of this analysis was our January ra%ng of Thailand as a rela%vely low poli%cal risk for Q1 2014; contrary to consensus forecasts. The Poli%cal Monitor score assessed that a number of underlying factors would limit the risk of the poli%cal crisis becoming a social & economic crisis. Since that ra%ng the Thai benchmark index has increased over 10%.
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Market-‐weighted performance of sovereign bonds -‐ sustainable & non-‐sustainable industrialised countries
Sustainable Non-‐sustainable World Government Bond Index
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Thai SET
THE RELATIONSHIP BETWEEN GOVERNANCE, RISK & PERFORMANCE
GOVERNANCE, RISK & PERFORMANCE – COUNTRY RISK!
Political risk, ESG & market performance! 6!
• The Sovereign Fixed Income Working Group (SFIWG) – established by the UN Principles of Responsible Inves%ng ini%a%ve – argues that investors can be`er gauge the risks of investment by considering social & poli%cal factors.
• The group’s research revealed correla%ons between
environmental, social and governance (ESG) factors and credit risks.
• Of par%cular note the group found:
• corrup%on and sovereign bonds performance are clearly correlated
• social factors – such as poverty, employment rates, food security, educa%on levels & popula%on distribu%on – are reliable measures of risk.
• The data can also be used to an%cipate future credit downgrades. The group noted comments from MSCI that a large discrepancy between ESG performance and credit ra%ngs is a strong sign of future downgrades.
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Jan-‐05 Jan-‐06 Jan-‐07 Jan-‐08 Jan-‐09 Jan-‐10 Jan-‐11 Jan-‐12
Market-‐weighted performance of sovereign bonds -‐ sustainable & non-‐sustainable industrialised countries
(Source: Sarasin, Datastream).
Sustainable Non-‐sustainable World Government Bond Index
GOVERNANCE, RISK & PERFORMANCE – COUNTRY RISK!
Political risk, ESG & market performance! 7!
• The SFIWG also found that countries with poor ESG
ra%ngs are likely to suffer greater loss as a result of unforeseen nega%ve events.
• In par%cular, countries displaying poor ESG indicators are ofen more prone to shocks from natural, social or economic events, leading to greater credit risk.
• The research and experience of working group members with regard to materiality indicates that ESG factors can be material to both creditworthiness and investment performance.
• In a separate study the Chief Risk Officer forum (CFO) noted that the tradi%onal focus on credit & financial risk was not designed to iden%fy environment, social & poli%cal imbalances and that capturing this data will provide addi%onal informa%on about emerging issues & help to be`er understand geopoli%cal developments leading to disrup%ve transforma%ons.
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Returns from poriolios based on the best and worst ESG rated countries
(Sources: AXA IM, JP Morgan, Ci%group, Thomson Reuters)
Worst ESG Best ESG
GOVERNANCE, RISK & PERFORMANCE – COMPANY & MARKET RISK!
Political risk, ESG & market performance! 8!
• The Poli%cal Monitor Australian Poli7cal Risk Index reveals an inverse rela%onship between poli%cal & policy uncertainty and market performance. As poli%cal uncertainty rises the ASX200 has trended downwards and vice versa.
• An increase in economic policy uncertainty foreshadows a decline in economic growth and employment in the following months (Baker, Bloom & Davis, EPU).
• Poli%cal risk measures are correlated with future equity returns (Harvey, Na7onal Bureau Economic Research).
• Poli%cal risk is applicable in more than just developing economies despite the literature’s focus on these markets with issues such as taxa%on, transparency, demographics and social issues all affec%ng the corporate environment with clear links between the level of risk and opera%onal performance in developed markets (Restrepo, Correia, Poblocian, Poli7cal Risk & Corporate Investment Decisions, 2012).
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Poli%
cal U
ncertainty Score
Poli%cal Risk Index
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ASX 200
Poli%
cal U
ncertainty Score
Poli%cal Risk Index vs. ASX 200
PRI ASX 200
THE POLITICAL MONITOR POLITICAL RISK METHODOLOGY
POLITICAL RISK– proprietary risk scores & indices incorporate a range of social & governance variables that increase the risk of poli%cal unrest
Political risk, ESG & market performance! 10!
Environmental
Climate change
Water resources and pollu%on
Biodiversity
Energy resources and management
Biocapacity and ecosystem quality
Air pollu%on
Natural disasters
Natural resources
Social
Human rights
Educa%on and human capital
Health levels
Poli%cal freedoms
Demographic change
Employment levels
Social exclusion and poverty
Trust in society / ins%tu%ons
Crime and safety
Food security
Governance
Ins%tu%onal strength
Corrup%on
Regime stability
Poli%cal rights and civil liber%es
Rule of law
Regulatory effec%veness and quality
Accoun%ng standards
Government finances
Poli%cal Monitor research focuses on social & governance variables that can provide an early warning of emerging social & poli%cal unrest.
COUNTRY RISK – proprietary risk scores tracking underlying poli%cal & social trends likely to shape the macro environment
Political risk, ESG & market performance! 11!
• Poli%cal Monitor country risk scores provide a rela%ve ra%ng of risk for some of Asia’s most important economies.
• The scores track over 10 different variables for each country providing insight into the likelihood of social and poli%cal unrest.
• The variables include social and governance indicators such as legi%macy of government, corrup%on levels, exposure to vola%le food prices, elas%city of demand, poverty and core demographic trends.
• The scores provide unique insight into the poli%cal risk environment by focusing on social and governance trends rather than a singular focus on economic data.
IN-‐COUNTRY RISK– proprietary risk scores and compara%ve analysis of Australia’s states & territories
Political risk, ESG & market performance! 12!
• The Poli%cal Monitor State Poli7cal Risk Index tracks over twenty key variables that reflect poli%cal risk in each jurisdic%on.
• The variables are classified across four categories -‐ Budget, Policy, Stability and Reputa7onal risk.
• The rela%ve risk scores allow investors to assess compara%ve risk across the four categories and determine which states offer the best prospect of a ‘no surprises’, stable investment environment.
• For individual firms the index allows compara%ve analysis of which states are most at risk of introducing new revenue raising measures and regula%ons that may hamper business investment plans.
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Total Risk Score
Budget Risk Policy Risk Stability Risk Reputa%onal Risk
State Poli%cal Risk Index March 2014
NSW Vic Qld WA SA Tas
SECTOR & FIRM RISK
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• Poli%cal Monitor examines the implica%ons of country and in-‐country risk for respec%ve sectors and firms.
• The process then assesses whether there are any sector or firm specific risks. This includes a review of community aptudes and global and domes%c industry trends relevant to respec%ve sectors / firms.
• The firm level analysis determines whether the poli%cal risk outlook places a firm at a dis%nct compe%%ve advantage or disadvantage to its industry peers. This isolates the nature of the risk and allows for responses to be tailored accordingly.
• A risk ra%ng with key influencing factors is then produced providing an understanding of rela%ve risk profiles.
Tax Gov Oversight
Content Mandates
Adver%sing Restric%ons
Risk Map
POLITICAL MONITOR RISK SCORES, ESG & ISO RISK MANAGEMENT STANARDS • Poli%cal Monitor risk scores track and weight economic, social and governance variables including unemployment,
infla%on, poverty, corrup%on, government transparency, food security, consumer exposure to price vola%lity and popula%on demographics.
• The scores and suppor%ng methodology are consistent with a number of the principles detailed in the Interna%onal Standards Organisa%on Risk Management – Principles and Guidelines standard (AS/NZS ISO 31000:2009), including:
• Principle (d): Risk management explicitly addresses uncertainty – the scores are designed to track variables that provide early warning signs of poli%cal and social uncertainty and for a number of scores / indices this is the explicit objec%ve
• Principle (e): Risk management is systema7c, structured and 7mely – the scores are backed by a clear methodology and are dynamic in nature (meaning they are regularly refreshed). In some instances Poli%cal Monitor scores are refreshed daily
• Principle (f): Risk management is based on the best available informa7on – the scores rely upon datasets not tradi%onally used in economic and credit risk assessment and therefore provide an addi%onal level of informa%on that is directly related to the market environment
• Principle (j): Risk management is dynamic, itera7ve and responsive to change – the scores are dynamic (meaning they are regularly refreshed) with some scores updated daily. The underlying methodology is also revised regularly to ensure appropriate factors are taken into account and weighted accordingly.
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ENOUGH THEORY: WHAT WILL YOUR SCORES, ANALYSIS & METHODOLOGY ACTUALLY SHOW US?
COUNTRY RISK – we track social & poli%cal variables and iden%fy trends ignored by tradi%onal economic analysis
Political risk, ESG & market performance! 16!
• In December 2013 Poli%cal Monitor rated Thailand a LOW poli%cal risk for the quarter ahead. This ra%ng was unique within the market.
• The Poli%cal Monitor risk ra%ng for Thailand reflected our analysis of underlying poli%cal and social trends that pointed to high levels of stability despite the poli%cal turmoil. These included low levels of youth unemployment, drama%c improvements in poverty rates and rela%vely high levels of food security.
• At the %me of wri%ng (March 14, 2014) the Thai benchmark index had increased more than 10% YTD and the Thai Bhat had traded in a consistent band, apprecia%ng around 1.3% against the USD YTD.
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USD vs THB
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COUNTRY RISK – our Australian Poli7cal Risk Index tracks poli%cal & policy uncertainty on a daily basis
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• Since its incep%on the index has shown a clear correla%on with the ASX200. As poli%cal and policy uncertainty rises the market trends downwards and vice versa.
• The index tracks a number of variables that reveal both the manner in which poli%cal events influence markets and the nature of that influence.
• The index is dynamic providing a daily reading of poli%cal and policy uncertainty in Australia and allowing for daily comparison against key indices.
• Consistent with best prac%ce risk management principles the index regularly undergoes review to deepen its insight and maintain robustness.
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Poli%
cal U
ncertainty Score
Australian PoliQcal Risk Index
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10 12
ASX 200
Poli%
cal U
ncertainty Score
Australian PoliQcal Risk Index vs. ASX 200
PRI ASX 200
ACCESSING THE DATA & INSIGHT • There is no ‘one size fits all’ model for assessing social and poli%cal risks. Every investor and each company has
different challenges and processes and the Poli%cal Monitor services are tailored to meet specific needs. However, there are a number of ways in which firms are currently accessing and using this data:
• Risk audits – twice yearly review of the social and poli%cal risks confron%ng firms in respec%ve regions or sectors. These audits are usually conducted for a firm’s risk management commi`ee as part of their broader commitment to ensuring management and investors are apprised of emerging and ongoing risks. The audits provide an opportunity for firms to gain a unique perspec%ve on risk that goes beyond economic analysis and helps firms meet their repor%ng obliga%ons. Audits include both quan%ta%ve and qualita%ve analysis.
• Consul.ng & advisory – a dedicated and focused review of the social and poli%cal risks confron%ng a firm or investor. The advisory service considers the implica%ons of country and in-‐country risk and then drills down to iden%fy sector and / or firm specific risks that are likely to influence the opera%ng environment over the coming months. These bespoke advisory services include both quan%ta%ve and qualita%ve analysis
• Poli.cal Monitor subscrip.on – our subscrip%on service provides daily access to our risk scores, indices and analysis providing execu%ves with comprehensive but concise analysis of the poli%cal risk outlook at a country and sector level.
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To find out more contact:!
!Damian Karmelich Steve Cusworth Partner -‐ Sydney Partner -‐ Melbourne p. 0407 772 548 p. 0417 178 697 e. karmelichd@poli%calmonitor.com,au e. cusworths@poli%calmonitor.com.au!
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About Political Monitor!
Political Monitor is a political risk research and advisory firm. Our analysis provides insight into the implications of political risk for commercial valuations, asset selection, investment decisions, strategic planning and operational decisions. !
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Information in this document is subject to change without notice and does not represent a commitment on the part of Seller.!
Seller does not warrant the accuracy, completeness or timeliness of any of the data and/or programs (“Information”) available within the report. The Information is provided “as is” without warranty of any kind, express or implied, including, but not limited to, implied warranties of merchantability, fitness for a particular purpose, title or non-infringement.!
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Copyright!
Copyright © Political Monitor Pty Ltd 2014. This document is copyright and contains confidential information that is the property of Seller. Except for the purposes of executing or applying this report, no part of this document may be copied, stored in a retrieval system or divulged to any other party without written permission. Such rights are reserved in all media.!
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© Political Monitor Pty Ltd 2014. All Rights Reserved . ACN 166 162 572.!
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APPENDIX 1 – THE RELATIONSHIP BETWEEN POLITICAL RISK AND ECONOMIC PERFORMANCE • Poli%cal risk is the second ranked concern for publicly traded companies … "Looking ahead, investors
con%nue to be wary about the effects of systemic risk, poli%cs and regula%on on the world's markets and how they'll perform.” (BNY Mellon, Global Trends in Investor Rela7ons, 2014).
• In general poli%cal instability results in:
• (a) lower economic growth (Aisen & Veiga, 2013)
• (b) reduced private sector investment (Alesina & PeroX)
• (c) increased infla%on levels & vola%lity (Aisen & Veiga, 2008).
• The economic effects of poli%cal & social instability remain for an observable period of 2 – 3 years. The key determinant of whether the effect of instability ceases at that point is the speed with which countries implement reforms & improve governance (Bernal-‐Verdugo, Furceri & Guillaume, IMF Working Paper, 2013).
• An increase in economic policy uncertainty foreshadows a decline in economic growth and employment in the following months (Baker, Bloom & Davis, EPU).
• The Interna%onal Monetary Fund (IMF) es%mates the economic loss to Libya, Egypt, Tunisia, Syria, Yemen, and Bahrain in 2011 at USD$20.56 billion as a result of poli%cal and social conflict.
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