In early 2018, Templeton Global Macro (TGM) published Global Macro Shifts issue 9—Environmental, Social and Governance Factors in Global Macro Investing [GMS-9]. The paper explored how we evaluate environmental, social and governance (ESG) factors in our macroeconomic research process and described the process of codifying the team’s research discussions into quantifiable scores. GMS-9 formally introduced our proprietary ESG scoring system, the Templeton Global Macro ESG Index (TGM-ESGI), which was one of the first methodologies in the sovereign fixed income markets to focus on projected changes in ESG scores as a source of investment insight.

Going forward, we intend to publicly update our TGM-ESGI scores on a recurring basis. This update contains a brief background on our ESG philosophy as well as an update on our methodology, notably including an improvement we made to adjust from overweighting S and G factors in previous iterations to an equal weighting of each of the E, S and G factors going forward. The paper also provides updated TGM-ESGI scores for 56 countries, along with brief case studies for three countries with improving projected scores and two countries with declining projected scores. As the sovereign ESG landscape continues to evolve, we also continue to look for ways to enhance and refine how we measure ESG factors and how we use that information to inform investment decisions.

TGM’s ESG Philosophy and Process

Below is a recap of the five key principles that define how TGM views the application of ESG factors in the research and investment process. These points reflect how TGM believes ESG can be best used by investors in the sovereign investment space.

  1. ESG is most effective when fully integrated into the other components of research, including traditional economic analysis and on-the-ground visits. These issues help form our core macroeconomic views on a country, and ESG factors are then expressed through analysis of economic issues such as growth and inflation.
  2. Focus is placed on forward-looking data points. Rather than current ESG performance, which is strongly correlated with income levels, we believe that momentum, or change in score, is the measure that truly matters for both investment performance and for where capital can be harnessed to generate the most positive impact.
  3. ESG is an important tool for identifying investment opportunities in addition to highlighting areas of risk. Within TGM, we are most interested in the “tails” signaling major ESG shifts in either direction.
  4. In order to benefit from ESG analysis, investors must have a sufficiently long time horizon. ESG factors guide a country’s fundamentals, which can be obfuscated in the short term by cyclical or temporary conditions. Conviction in the view and patience to see that view come to fruition are requisites to successful ESG investing.
  5. Emphasis as investors on a country’s long-term fundamentals provides an effective base from which to open communications with policymakers interested in discussing best economic practices. This dialogue is important for our ability to serve clients, and for government officials interested in the perspectives of private markets.

ESG Methodology

The TGM-ESGI is the composite of 13 subcategories (see GMS-9, page 4) determined to be material to macroeconomic performance, scored from 0–100. The research team assigns these scores by overlaying their views on specific global index scores and then providing projected numbers for how conditions are expected to change over the medium term. The final scores are calculated by applying an equal weight of 33% for governance, 33% for social and 33% for environment, with the projected change in scores simply being the projected score minus the current score.

Refinement of our environmental scoring

The equal weighting across the E, S and G scores represents a refinement in our scoring process—we previously weighted the E factor lower at 20% (with S and G each at 40%), given our view that environmental factors typically develop over relatively longer time periods. However, we have revised that assessment given that environmental factors have, in our view, recently had increasingly acute effects on a growing number of sovereigns. The adjustment to an equal weighting of E factors has had a modest effect on the overall country scores thus far and has not materially altered our current investment views. However, the potential for environmental factors to have a greater impact on our investment views going forward has increased due to the higher weighting.

Part of the drive to equal weight the scores is in recognition that environmental factors are becoming urgent concerns in major emerging countries like India and Brazil, among others. A number of countries have also been enduring above-average environmental events for decades, including countries in the Horn of Africa, with its droughts and concomitant lack of food security, or in certain Caribbean nations that remain exposed to devastating natural disasters but lack sufficient capacity to cope with their impacts. The longer-term impacts of environmental trends and (mis)management of the environment remain well-known concerns. For instance, a World Bank report found that environmental degradation costs India US$80 billion per year, a rate that would threaten the sustainability of future economic growth.1