RBC’s EM bond fund an RI gem

The 2018 FundGrade A+ Awards will be presented in January. Fundata awards the FundGrade A+ to the top-performing funds every year. The Award highlights the best funds in each category based on up to 10-years of risk-adjusted performance, measured by a fund’s Information, Sortino, and Sharpe ratios. However, returns and risk are not the only way to measure performance. And this is particularly relevant in the Responsible Investing category.

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 Leaders/Laggards).

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 A+ hopeful 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 attributes.

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.

the Fundata ESG Rating Methodology

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