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Jan Anton van Zanten (JAvZ): With our framework, we don’t look at how rich your country is currently, we don’t look at financial materiality. We basically look at whether you have good policies for the SDGs. Do you need better access to capital as a country? And are you respecting key principles for the SDGs?

Welcome to a new episode of the Robeco podcast.

Erika van der Merwe (EM): How do investors know whether an asset is sustainable? Well, the investment industry relies on dozens of screening methodologies and frameworks to select stocks and bonds that are aligned with sustainability objectives. Now, arguably, the exercise is a blend of art and science, and the challenge is to design a process that’s objective and repeatable, and that does contribute to better outcomes.

My guests are part of a team that recently launched a new screening methodology, one that they believe helps in the construction of sustainable fixed income portfolios. So welcome to Jan Anton van Zanten and Laurens Swinkels. Jan Anton is Robeco’s SDG strategist and Laurens is head of quant strategy in Robeco’s Sustainable Multi-Asset Solutions team. Great to have you in our studio.

In unison: Pleasure to be here.

EM: Well Laurens is suitably attired with a very bright orange tie. I am sure it means something. Jan Anton?

JAvZ: I think he’s just very happy to be back in the Netherlands, all the way from Norway.

Laurens Swinkels (LS): Exactly. It’s my party tie, so it’s very good to be here.

EM: Well, it’s also party time because you’ve launched this framework, and both of you are researchers. You both have PhDs. So I know there’s a rigorous underpinning and so far I think it’s been well received. So you’ve called it the country SDG framework. What is it? What does it do? Jan Anton.

JAvZ: So basically we believe at Robeco that if you’re a sustainable investor, you want to invest in activities that are good for the world. So basically that then begs the question of what is then good for the world? And we believe that the Sustainable Development Goals give you a blueprint of the objectives that basically all countries around the world want to achieve by the year 2030. So with that in mind, we, of course, for a long time already, have a company SDG framework that is assessing the impacts that companies are making towards achieving the SGDs.

And now we were thinking together with Laurens and other colleagues, how can we replicate this for government bond portfolios? So basically we asked ourselves the question which of the countries in the world should you be investing in if you want to promote progress on the SDGs? And we created a framework that helps us to analyze that. So basically, we’re analyzing all countries in the world on their performance on the SDGs, on their trajectories towards closing the SDG gap, and that gives us scores that we can then integrate into the investment process.

EM: Lots of questions to ask. And Laurens, you might want to add to that. But my immediate question is we already have so many rankings and ratings and frameworks. What’s special about this one? You know, why would you get investors attention with yet another framework?

LS: I think it’s very important to know what the goal is when you are investing and there is the country sustainability ranking that we have at Robeco, and there we also look at sustainability, but we look at it from a financial perspective. So does this risk or opportunity help us believe that countries are actually paying back the debt that they have issued to us?

EM: So that’s for the country’s sustainability ranking?

LS: Yes, exactly. But for the Sustainable Development Goals, the SDG framework that we developed, the priority is to look at how can we promote best progress on the SDGs. And that may be a different question than “Which country is most likely to pay back the debts that we issued?” So that’s two different lenses, so to say, on how you can look through sustainability and apply it differently in investment portfolios depending on the goals that you have.

EM: So that’s an important point to make then. So the underlying assumption or belief or philosophy is that you believe in the SDGs, you believe that aligning with them creates better outcomes. And it’s not about financial materiality..

JAvZ: It’s all about sustainability. So we know that, you know, all countries in the world adopted these SDGs. They want to achieve that to create a better society, a better planet. But that means that a lot more money needs to be invested in these SDGs. And we know that some countries in the world don’t sufficiently have access to capital to invest in the different SDG areas like healthcare, education, fighting climate change and so forth. So with the country SDG framework, we’re not looking at how sustainable is a country today, but we’re basically looking at which countries have good policies for the SDGs and which countries need better access to capital, because those are the countries that we would then want to invest in if we want to build an SDG-aligned government bond portfolio, for instance.

EM: And indeed, Laurens, is this about bond investing and really encouraging the development of these countries bond markets?

LS: Yes, that’s certainly part of the answer here. So I think for government bond investors, it’s always a dual objective because why do people invest in government bonds? Partially it is because they want to have a safe asset, but there’s always some credit risk, some default risk that you don’t get paid back what you invested in these countries. So when I think about how you can apply the framework, I always think you have to separate these two goals because you can always mix them up and then the discussion gets quite blurry.

So how I think about it is to have one portfolio that is a very safe and liquid portfolio. And also there you can think about which of these safe and liquid countries contribute to or detract from SDGs and use our the framework there. But on the other hand, you can also look at a portfolio that is maybe a little bit more credit risky, but where the marginal revenue in SDG terms is very high.

And as a sustainable investor, you might actually want to invest there and develop these bond markets because there you think 1 euro invested there gives a very high reward in terms of SDG progress. But that might not be the countries where it’s most likely that you get paid back that euro. So there will be some default or some currency crisis or something in that area that is unavoidable. But the alternative is only to invest in the countries that are already safe, liquid and have already very much developed bond markets.

EM: So what I’m understanding is that you can’t do it alone because a strong SDG-related rating doesn’t mean that it’s an attractive market from an investment perspective. So just to give you a sort of an illustration on this, taking bonds issued by emerging market governments, for example, and I’m sure this is to a large extent what you have in mind.
I saw there’s a World Bank paper published late last year. It looked at investor demand for ESG-themed bonds, and they found that while investors do have appetite for such bonds, they did express some clear concerns. And this included weak bond frameworks, lack of institutional capacity of the issuing governments and limited data availability. So it doesn’t necessarily mean that it’s super investable or that investors are going to have good outcomes.

JAvZ: Yeah, I think that’s what’s so attractive also for me working with Lawrence is to get this perspective of how do we integrate this in investment portfolios. And when you think about allowances, you can create an investment solution that on the one hand looks at liquidity, it looks at which are safe countries that are maybe a bit more developed but that still have good policies for attaining the SDGs. So they have policies for which we have the evidence that they work towards attaining these goals.

But then you can still take a part of your investment or part of the assets that you’re managing and to invest that in the countries that maybe are a bit more risky. But of course, we see that a lot of emerging markets are quite a few of them have very good SDG scores. But then having a good score is only part of the investment process. So then we can still think, well, a country like Ghana gets a very high SDG score as good policies. We can go into the details maybe later, but then of course, later on you want to do your regular investment analysis, you want to know what is the likelihood that the Ghanaian government is then going to repay the debt because, of course, as a good investor, you also want to do that part of the investment process.

EM: And that’s a good example because they did default on their debt. Related to that, what are your views and maybe I can ask you, Laurens, what are your views on whether such ratings and methodologies truly change outcomes for countries? And at the basic level, whether investor action contributes to more capital flows to sustainable countries?
And I’m going to use your own research here. So we’re talking on the country level, I know, but using companies as an example, I know you know where this is going. The two of you worked with David Bliss on a paper entitled ‘Does Sustainable Investing Deprive Unsustainable Firms From Fresh Capital?’ You concluded “we find no evidence that fresh capital is flowing more towards sustainable than unsustainable firms. And also it’s an open question whether more widespread adoption of sustainable investing would have a more noticeable impact on capital flows.” Well, so could it be that the same applies to sovereign bond issuance that we may not necessarily see more capital flowing to these SDG positive nations?

LS: Well, here I think what we did and that the paper you kindly refer to is that actually I think my conclusion from that is that there’s not enough sustainable investing at the moment. So because there’s also a lot of capital that unsustainable investors but investors that reward capital to apparently unsustainable companies.

So I think for these frameworks to actually determine capital flows in a meaningful way, we need to have a lot of investors that follow the same framework to actually allocate to these countries or companies that do good things and therefore make the interest rates they pay on the debt – because in the end they have to issue debt. But of course there’s interest payments attached to it and also make it cheaper for these countries. And the more demands there is for these government bonds, the cheaper it is for them to invest, and the more profitable it is or the fewer expenses they have to build hospitals, have more education and so on.

So also in that paper, we didn’t express the hope that that would be no more capital to sustainable companies. Actually, the hope is that it will happen, but we just need a lot of the investment industry behind the idea to actually make that happen. So it’s a call to action for the investment industry.

EM: Let’s move on to the practical application of your methodology. And I’m sure this is where it gets super exciting. I know you’ve spoken to some multilateral organizations about the methodology with some good reception there. Let’s start with what were some of the notable findings related to this framework. So, for example, how do you develop market countries fare compared with emerging markets?

JAvZ: I think that’s also where the novelty of this new framework comes in. So the World Bank, the way they often do these assessments of what the sovereign ESG ratings look like. And then the World Bank argues that sovereign ESG ratings – and they call it an ingrained income bias. So they conclude that sovereign ESG ratings, they tend to be highly correlated with income, basically meaning that the richer the country, the higher the ESG score.

But that leads to a worrying conclusion because, you know, it incentivizes capital to flow more towards rich countries rather than to the poorer countries. But if we think about achieving sustainability objectives like the SDGs, then what we also know is that emerging markets need a lot more capital. So with our framework, we don’t look at how rich a country is currently. We don’t look at financial materiality. We basically look at, okay, do you have good policies for the SDGs? Do you need better access to capital as a country? And are you respecting key principles for the city?

So those are basically the factors that we’re looking at. And then what comes out of it is that the countries that are ranking on top, they get the highest scores, often the emerging markets. We also have a large segment of countries with positive scores that are more developed countries but that do have good policies for the SDGs. An example could be Denmark – good policies for wide variety of SDGs, according to the data. On the neutral side, we have some bigger markets, more also developed countries. And then on the negative scoring side, we have countries with really poor governance, countries involved in war, countries that are basically dictatorships. So those would be on the negative side or countries simply with really poor policies for the SDGs because that’s what we captured as well.
So I think that’s the novelty. You have a score that’s not correlated to income and it looks at something different than existing sovereign ESG ratings and that can be used in a complementary way.

EM: So that’s really the value addition of this methodology. Laurens, were there any surprises that you found on where certain countries ranked?

LS: Before I knew much about the framework, I was expecting that there would be a higher correlation between the sustainability ESG score and the SGD scores. But I was actually positively and happily surprised that the correlation is, well, it’s not zero, but it’s very low. And mostly where there is a positive correlation is on the examples that Jan Anton gave, where there is a high level of corruption that is bad for both scores. But on the positive side, the correlation is actually very low. So that also means that you can use this in a complementary way, both of these rankings. So that was something I initially had my doubts on, but I was positively surprised when I when I saw the outcome of the framework.

EM: Are there common reasons why certain countries fail and inverter commas fail this test, in other words, have a negative SDG ranking. You mentioned corruption.

JAvZ: I think corruption is a big one. Poor governance is a big one because governance and corruption, they go hand in hand, of course, but those are a key building block for having good policies. So what we find is that countries that have a poor score related to their institutional quality, so the quality of their governmental capacity basically, they tend to score poorly on other SDGs as well.

And that’s quite interesting and I think that’s also well documented in economic development literature. It shows that if you want to develop as a country, you need to have good institutions, you need to have good quality of government. So I think that’s one. And also quite worryingly, what we find is that quite a lot of countries score quite negatively on SDGs related to biodiversity and ecosystems. So especially SDG 15 ‘Life on Land’, we find that the majority of countries in the world score negatively there, quite simply because of things like high deforestation rates, high land degradation rates or very limited protection of ecosystems.

EM: Would you, Laurens, describe this as a forward-looking methodology that helps investors look beyond the status quo?

LS: I think most of the frameworks that we have are actually forward-looking, so that’s what I tend to think.

EM: That’s one of the big challenges right now with sustainability investing is to not just use data of the recent past and history, but to be able to know how things are going to change into the future.

LS: In general, I think that’s why our profession is very challenging because we are only looking in the rearview mirror and we have to try to look forward. So this is maybe also something that can really help in that. But I think it’s something that we always try to do.

I think the main novelty here is that we have taken this income bias out of the system, out of the framework, so that you can really, as an investor, separate this. Am I certain that the money is being paid back or is the marginal dollar of my investments being used in the best way? I think that’s the very clear advantage that also the World Bank was calling for: to look more at that part of the equation. And that has a forward-looking element to it because if we want to reach the SDGs or make sufficient progress in 2030, then we have to commit a capital there where we have to progress and actually make this real impact in real life in the next 5 to 10 years.

JAvZ: If I could maybe add to that. So in terms of the methodology of how we do it, I can give you an example. When we talk about forward-looking metrics, I think there’s certainly forward- looking components into this method, and one of them is, for instance, when we see how countries are doing on SDG 3 on health care, health and well-being. What we do is we take a lot of data from the World Bank, from the United Nations, linked to the official SDG targets, and then we use an indicator, for instance, maternal mortality. We see how many women are dying when giving childbirth. And for a country like Ghana, we see that this is declining very rapidly over time.

So in the past ten years, we see a big drop in maternal mortality. It’s still high and also relative to other countries in the world. So still too many women are dying when giving birth. But it is on a very good downward trajectory. So we say, well, we can use that information, that trajectory as a proxy for policy. So because it’s declining so rapidly, we then infer from that that it’s actually very likely that Ghana has good health care policies.

And then, of course, we use additional data. We look at infant mortality also declining rapidly in Ghana. We also look at capacity. We see the Ghana’s investing more and more of its GDP into health care. So taking that together and also by looking at the trends over time, we do not so much look into the rearview mirror or in the current mirror like where does the country stand today? But we’re checking what is the trajectory and does that make it likely that the country has good policies for the SDGs? And if so, then we would like to finance that, of course, from a sustainability angle.

EM: At the beginning I said one of the challenges with frameworks is that it needs to be objective and repeatable. And I think another one is that it needs to be comprehensive, so covering as much as the investment universe as possible. Laurens, if you look at the practicalities and the example you gave now of healthcare, I mean, that’s just one little metric. That’s a subcomponent probably of an SDG. So give us some stats. Well maybe let me ask this of Jan Anton. How many metrics and variables did you have to look at? And do you feel that you do have universal, comprehensive coverage?

JAvZ: So we have 17 SDGs, as most people know nowadays with 169 underlying targets, and they have more than 200 indicators. So that’s what the UN says. What we use in our model, we have more than 90 variables linked to those SDGs. So it’s not.
EM: Like proxies, right?

JAvZ: Proxies, basically. Some of them are official metrics by the UN, some of them are proxies. We feed all of that data and we have a quantitative model and algorithms to analyze the data to determine which countries are having good policies. But we do see that there’s quite a few data gaps.

On the one hand, that’s due to the United Nation agreeing to all of these indicators and targets, but for some of them, they don’t even know how to measure it. So the UN Statistics Office is really busy finding methodologies for measuring all the SDGs. But I thought that’s quite interesting that the UN is setting all these targets without having adequate methodologies for some of them.

Then some countries are not reporting on all the different metrics. So we do see that sometimes data is very sparse. Some countries do not report on some indicators at all. Others they have very big gaps in terms of the report in 2015 and then maybe in 2018 again. So there’s data gaps there, but we have methodologies to also fill those data gaps, find the outliers, clean the data and so forth.

EM: So it’s a new methodology. Are your investment teams on board with us? Are they already applying it, Laurens?

LS: I think that’s good because it’s always nice to have a sustainability policy. That’s why it’s so nice to work together with Jan Anton because I can try to look through my investment glasses at the framework and say, what would I do with it as an investor? And we have already seen that investors think the SDGs are important and they were actually looking for frameworks to actually apply because it’s a lot of thinking has gone into it.

Mostly now I think we have seen investors looking at this safe and liquid part of their portfolio to look at which countries contribute positively or exclude countries that detract from SDGs. But I think that’s the first step because many government bond investors, actually a large part of their portfolio is in these safe and liquid countries. So for them, that’s the biggest part that they want to put attention first.

But then when I think about if you want to follow this through completely, then you need to apply it to your whole government bond portfolio. And I think then it becomes actually much more attractive because that’s where you can really have more impact because these safe and liquid countries, they’re typically the richer countries that already have quite a developed bond markets and so on.

But that’s also where it gets a little bit more scary maybe as an investor because typically some of these countries have large bond markets, but not all. Of course, they also have currencies that are maybe less stable in certain times. So there I think it’s instead of focusing on one or two countries could be quite risky Their approach would be to have a very diversified portfolio because there’s all kinds of risks. But that’s actually what we know from investing: if you diversify these risks and many of these risks are very local. So it could be like an election gone wrong or something like that. But if that’s the case, you can diversify the risks.

And these SDG, the positive, the +2, +3 scores, they’re spread out over the world to get rid of this local risk and I think that’s where the most added value would be for investors to apply it also there. And when I say added value, it’s maybe because the yields are higher, because higher risks typically come also with somewhat higher yields or higher returns, but also the sustainability, or the impact that you can have as an investor is large there.

So I think that’s the nice combination to look at. When I looked at the scores because Jan Anton made the scores for 160 countries, something like that. Actually, one of the problems is because many countries that score well, they actually don’t have investable bond markets. So even though we would maybe as investors think that would be a good country to invest in, to promote healthcare or education or environment, etc, but they don’t have developed markets. So we can’t really buy these bonds. So I think if you would think even further down the line, asset managers or the asset management industry could think about helping these countries to develop bond markets so that they do have access to international capital, which tends to be cheaper than only having access to local capital.

EM: I want to start bringing it to a close. And the point that you just made, Laurens, touches on the question of engagement. Does engagement fit into this theme here? If you see that potential that Laurens has just identified yet, is there scope here for engagement with countries?

JAvZ: Well, I think definitely so. As a bond holder, you can certainly go to a country and say, hey, I’m invested in your country, I care about your country. But I have some concerns about some of your sustainability progress. So you can definitely do that. Robeco has been engaging with some countries around the world on topics like deforestation and climate change. So I think that could go hand in hand.

Of course, sovereign engagement is difficult, one of them being that, of course, you don’t have an actual vote and you shouldn’t want to because you want to respect a country’s sovereignty and democratic principles. But I think as an investor, stepping up and voicing to a government also your interest in the country, your interest in sustainability transformations, and also explaining how that then relates to you as an investor and maybe your ability to further finance country. I think that dialogue is really important.

LS: And I think actually as a bond investor, I think many people when I talk about engagement, it’s about the stock markets and equity markets and so on. But I think as a bond investor, both on the corporate and on the government side, you have a lot of power because once a stock is issued, it is there and it’s just trading in secondary markets. But bonds mature and once a bond is matured, the country or a company has to issue a new bond and convince investors that it’s actually a good idea to put fresh money to invest in that bond. So I think there’s a lot of engagement possible because every, I don’t know, three, five years when a new bond is issued, there are roadshows and investor meetings where you can show the progress that you made as a country towards SDGs and why you have developed on ESG scores. So I think there’s a lot of engagement possibilities with investing, maybe even more than with the stock markets.

JAvZ: And what’s actually nice about a framework like this country SDG framework is that it’s first of all based on a framework that countries adopted themselves. So you can go to a country and say –

EM: There’s commitment.

JAvZ: There’s commitment already. So you can go to the government and say, hey, you adopted these SDGs. We also care about these SDGs. And then within the framework like this, we have all the underlying data so we can track exactly how a government is doing on implementing all these SDGs. And so that gives us a good factual basis for such a dialogue and conversation with the government.

EM: On the scoring with this methodology, it’s a three-step process, as you alluded to a little earlier on. And the outcome is a score ranging from -3 to +3. Give some examples of countries that rated poorly in terms of the framework as well as the really good ones.

JAvZ: Yeah, of course. So on the negative side, for instance, some usual candidates that come to mind are Russia because of the war; Afghanistan, for instance, poor institutions and major challenges also due to the internal conflict that’s been happening there. You also see a country that’s maybe a bit more surprising Ireland. Ireland has very high fossil fuel subsidies, clear conflict with SDG 12 on responsible consumption and production. We also know that in Ireland we see challenges with water consumption, we see challenges with sustainable cities and making them more resilient to natural disasters.

On the more neutral side, we see, for instance, a country like the Netherlands not having great policies for the SDGs, but also not detracting so much from them or maybe even Germany. And then on the positive scoring side, well, countries that get the top scores are often emerging markets. Think about Ghana and Senegal, both with plus +3, the highest scores, or also a country like Albania making good progress on some of the SDGs. Good policies that would also get a high score.

EM: Laurens, final word to you. What are the next steps from your perspective as both an investor and a researcher?

LS: The next steps are to think maybe even more deeply on measuring the impact because it’s always good to have the intention to have impact, but to actually measure the impact that we have as investors. And I think that’s one of the biggest challenges as a researcher to make sure that what you think you have impact to be able to show that to the investment world, because that’s what makes my heart feel better about these topics make the world a better place.

EM: Thank you so much for joining us and for your insights on this.

JAvZ: Thanks so much, Erika.

LS: Yeah, thank you, Erika.

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Thanks for joining this Robeco podcast. Please tune in next time as well. Important information. This publication is intended for professional investors. The podcast was brought to you by Robeco and in the US by Robeco Institutional Asset Management US Inc, a Delaware corporation as well as an investment advisor registered with the US Securities and Exchange Commission. Robeco Institutional Asset Management US is a wholly owned subsidiary of ORIX Corporation Europe N.V., a Dutch investment management firm located in Rotterdam, the Netherlands. Robeco Institutional Asset Management B.V. has a license as manager of UCITS and AIFS for the Netherlands Authority for the Financial Markets in Amsterdam.