The way we invest is changing, driven by a fundamental shift in how companies are being viewed and valued. Where once we considered only risk and return, at Schroders, we now assess a third dimension - impact risk - that needs to be embedded into the investment process. We have built tools to assess the impact, both positive and negative, of the companies we invest in, empowering our portfolio managers to assess the true impact of each company; their "impact-adjusted profits".
In 2019, we launched our proprietary impact measurement tool SustainEx™. It measures the costs or benefits companies impose on society, to understand their true profits, or their ‘impact-adjusted profits.' Using the same logic, we have now developed Sovereign SustainExTM. This extends our analysis to the country-level to help us quantify the positive and negative impacts countries have on the rest of the world.
WHAT IS SOVEREIGN SUSTAINEXTM?
Sovereign SustainExTM is a tool which measures the global costs and benefits arising from specific activities, and how countries contribute positively or negatively to these. Schroders' country-focused SustainExTM framework examines 26 measures of social and environmental impacts attributable to sovereigns, leveraging the insights of over 750 academic and industry studies to quantify the global costs and benefits we have identified. We apply the resulting analysis to over 150 governments.
TRANSLATING IMPACTS TO COSTS
We translate all of the impacts we have identified into economic costs or benefits, measured in monetary terms. This quantification relies on systematic analysis of global impact costs or benefits, country exposures and impact attribution. There are three broadly- defined models to translate externalities into social or environmental impacts, as outlined in Figure 1. We use consistent assumptions across sovereign and corporate securities where measures overlap, to enable comparability.
Global value: attributing impact in proportion to countries' share of the activity
Where impacts are most robustly estimated at a global level, we attribute the total cost or benefit to countries in proportion to their share of the activity.
For example, biodiversity loss is among the top global risks to society. According to the OECD, natural forests declined by 6.5 million hectares per year between 2010 and 2015 (in total, an area larger than the UK), and natural wetlands declined by 35% between 1970 and 2015. Over 30% of corals are now at risk from bleaching, and 60% of vertebrate populations have disappeared since 1970. Land use change, over-exploitation of natural resources, pollution, invasive alien species and climate change underpin the threat.
Biodiversity protection is fundamental to achieving food security, poverty reduction and more inclusive and equitable development. We calculate a country's contribution to biodiversity by combining their land area with a ranking of their protection of ecosystems. Each country's share of that total is multiplied by the global annual cost of biodiversity loss attributed to public sectors.
Unit activity: combining country output with unit impact estimates
Some social and environmental impacts are measured in terms of the impact of a unit of activity, such as the damage caused by each tonne of carbon dioxide released.
We estimate the cost of each country's carbon footprint by using consistent assumptions for the cost of carbon across countries. Based on the academic studies we have examined, we arrive at an average cost of $85 per tonne of carbon emitted. Our analysis of the impacts of countries on carbon emissions uses the estimated annual emissions (in tonnes) attributable to countries' public sectors rather than national emissions to avoid attributing costs already attributed to companies.
Monetary: examining the monetary value of countries' action
Our final approach to estimating countries' costs or benefits is based on how much countries spend on that particular activity.
For example, education. There is a clear relationship between those countries which have invested most heavily in education and those which have benefited from the most rapid economic growth. To the extent that education focuses on younger cohorts, the benefits of that investment will emerge in the future, while underinvestment represents a drag on future development. To arrive at the social benefit of education, we calculate the difference between average public spending on education per capita under 20 and the required level implied by each country's income, multiplied by the population under 20.
HOW CAN SOVEREIGN SUSTAINEXTM BE APPLIED?
As an investment tool
By using an objective, transparent and robust methodology grounded in academic research and industry analysis, Sovereign SustainExTM provides Schroders' analysts and fund managers with a consistent measure that is comparable across countries. It helps them to identify the countries facing the most significant risks and to understand where those risks stem from.
To assess portfolio impact
Increasingly, investors want to understand the social and environmental impact of their entire investment portfolio, spanning asset classes. The Sovereign SustainExTM framework can be used to assess portfolio level impact across a range of sovereign assets (e.g. an emerging market debt fund), or combined with SustainExTM to measure the impact of an equity, credit and sovereign portfolio. By providing the flexibility to apply different lenses to the outputs, investors are able to focus on the priorities that are most important to them.
To find out more about Schroders' analytical tools and how they help us quantify the sustainability risks and impacts of assets we seek to invest in, please click here.
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