More than a year after NN IP saw half of its emerging market debt (EMD) team leave due to a conflict around the firm’s ESG strategy, the team is back at full strength. ESG integration has been the main priority of NN IP’s new head of EMD Marcin Adamczyk.
At the end of 2019, then head of EMD Marcelo Assalin left quite suddenly to US competitor William Blair, taking 10 colleagues with him. When we speak to Assalin’s successor Marcin Adamczyk, who rejoined NN IP in July last year after a stint in Poland, NN IP’s EMD team of Hague asset manager NN IP is again 26 people strong, including the six-person EMD team of MN that was acquired in September last year.
‘We have expanded the team with two EMD analysts, specifically for sovereigns›, says Adamczyk. ‘Previously, we also took ESG criteria in consideration, especially governance, because this largely determines whether a country can repay its debts. But it was not explicitly mentioned like that,› says the Pole, who previously worked at NN IP (and its predecessor ING IM) in The Hague between 2013 and 2017.
Environmental and social criteria (the E and the S) did not receive specific attention until recently. ‘This is because there is no strong evidence that this adds alpha,’ says Adamczyk. ‘But we think it will in the future, which is why we thought it was time to develop a model that combines all these factors.’
No exclusion but inclusion
The EMD-team decided not to copy the approach that the MN team introduced at Pensioenfonds Metaal & Techniek (PMT) two years ago for its investment funds. At the time, PMT excluded 40% of the countries in its index because they did not meet the pension fund’s strict sustainability requirements. Instead, the firm has opted for positive selection.
Adamczyk cites two reasons for this. ‘First, ESG is still in its infancy in most emerging markets, which entails the risk that you are left with a portfolio that’s not diversified. Also, the very countries that may be scoring worst now but are showing improvements in some areas may be the ones that need your capital the most. If you exclude those countries now, you deny them the capital they need to continue that progress.’
The second reason is that it is intrinsically difficult for a fund to pursue a strict ESG policy, says Adamczyk. ‘An exclusion policy is easier at the mandate level because then you are dealing with one client with one set of requirements. Put a hundred investors together in a room and you get a hundred different definitions of ESG. In an investment fund, therefore, it is better to take an inclusive approach without too many exclusions.’
Nevertheless, Adamczyk does not entirely exclude the possibility that NN IP will eventually go for the exclusion route as well. ‘We launched an ESG-optimised version of our hard currency fund last year. This is a semi-passive strategy that replicates a slightly adjusted benchmark. This excludes the 15-20% worst performing countries in ESG terms, such as Venezuela and Ecuador. Every quarter we do a rebalancing.›
Adamczyk does not yet want to judge the success of this approach because of its limited track record. ‘So far, the fund is lagging behind a bit, also because precisely in the second half of last year the ESG laggards did very well.’
Stability score
Just about all asset managers these days claim to be integrating ESG criteria in their investment process. Even in a traditional laggard like EMD, this is increasingly becoming the rule. According to Adamczyk, NN IP›s new approach distinguishes it from its competitors by the forward-looking aspect of its model.
‘Most ESG data are related to the past, and are not published often enough to be of real value in the investment process,› says Adamczyk. He does use this kind of data, which covers countries› scores on issues such as climate policy, education, demographics, democracy, rule of law and a range of macroeconomic factors, to assign ESG scores to countries. But a so-called ‹stability score› has been added to the model. The stability score is based on NN IP›s own research and counts for 50% in the assessment of the total score, which informs the specific allocation to a country.
‘This stability score relates to the political climate in the country, the degree of ethnic tension, the sensitivity to environmental disasters and the degree of terrorism threat. When we did a backtest with the addition of these stability scores to our model, it turned out to have considerable added value,› says Adamczyk, who believes this is mainly due to the fact that these stability scores are based on current developments in a country. ‘These are often not yet priced into the markets.’
Ukraine
Adamczyk gives an example of the effect of adding the stability score. ‘Take Romania and Turkey, two countries that have roughly comparable scores in our standard ESG model. But Romania scores among the best countries in terms of stability [with a score of 4 on a 100-point scale, where 1 is the most stable and 100 is extremely unstable], because it has hardly any ethnic or social tensions and relatively little vulnerability to environmental disasters.›
For Turkey, it is a very different story. NN IP gives that country a stability score of 67 because of the social and political instability in the country.
But qualitative analysis is also necessary, because the stability score does not tell the whole story. ‘Every week, the ESG outlook of a country is taken into account in the positioning,’ says Adamczyk. ‘Look at Ukraine, for example. A number of positive developments have taken place there recently, such as the introduction of a reform programme by the IMF and the appointment of a new, independent central bank governor. Yet Ukraine’s stability score is quite low, mainly because of the war in the Donbass region and Russia’s annexation of Crimea.›