For investments in company shares, or corporate bonds, those in certain sectors might be ruled out entirely because of the negative effects they are perceived to have on society or the environment. Individual companies may be excluded from portfolios, perhaps because of poor governance or harmful activities.
When it comes to investing in bonds issued by governments, the wide range of activities they perform might make it harder to assess whether they meet the traditional definitions of responsible investment.
Delivering public good
I believe it is better to consider the benefits that government spending and policies bring over time, and enabling investment in government bonds, rather than focusing on negatives. The large share of government spending that focuses on delivering public services such as healthcare and education, means that the net effects can be very positive for society.
Of course, the extensive variety of ways in which governments spend their revenues means few will be beyond reproach from the strictest interpretations of ESG qualifying criteria. This means some investors may prefer not to hold government bonds at all, based on government spending on certain functions like defence, which will entail the purchase of weapons.
However, we should also remember that the majority of any government’s revenues are likely to arise from taxation rather than from sales of bonds, further diluting any links between government bonds and spending that may be considered detrimental. Where a government’s activities are seen to benefit society or the environment through regulation, I believe that investing in that country’s bonds can be wholly compatible with an ESG approach.
It is important to note that investing in any particular government’s bonds should not in any circumstances be seen as an endorsement of an incumbent political party or of its agenda, or as expressing a political view.
Weighing up the impact
Before investing in a government’s bonds, I believe it is imperative to assess the fundamental characteristics that could affect a country’s ability to service and repay its debt alongside the value any investment may offer. These characteristics include its fiscal and monetary policy, economic trends, and the political intentions and social environment.
However appealing the fundamentals appear, any government must also pass a detailed ESG assessment. A first step might be to screen issuers using independent ratings that evaluate governments on a number of ESG metrics, such as socio-economic factors and financial management. Only those meeting certain standards remain as candidates for potential investments.
These ratings should be supplemented with further qualitative analysis, in my opinion, using research available from authoritative sources. The purpose is to satisfy ourselves that a country meets certain standards with respect to the rule of law, human rights and the environment, among other important considerations.
I believe governments that score highly on ESG metrics are more likely to prove lower risk investments. After all, a perception of good governance will likely be reflected in the ability and willingness of governments to keep up with repayments to their bond holders. Similarly, improving living standards, health care, and education will increase an economy’s potential growth over the long term, reducing financial risk for investors who hold its long-term bonds.
Too important to ignore
The complexity of evaluating government bonds through an ESG lens is not a good enough reason to shy away from investing in them. I believe that government bonds merit full and fair consideration for inclusion in portfolios screened for ESG attributes.
For one, it is clear that governments have a huge role to play in positively shaping the very challenges that responsible investors care about. From an investment perspective, they are also an asset class that can play an essential part in a diversified portfolio.
When we are looking to allocate investments across a mix of global assets to achieve an attractive balance of risk and return, government bonds can have an important role to play, and that is difficult to replace.
The views expressed by the author should not be taken as a recommendation, advice or forecast.
The value of the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.