In August, ERSTE RESPONSIBLE BOND EM LOCAL was awarded the Austrian Ecolabel. That’s a reason to look behind the scenes of this emerging markets bond fund. We spoke with Senior Fund Manager Anton Hauser.
In the past, your fund was occasionally invested in countries that had some catching up to do in terms of environmental and social standards. Why, then, was the fund classified as sustainable by a state authority?
Hauser: ERSTE RESPONSIBLE BOND EM LOCAL was launched in 2008. This made it possible for the first time for a broad investor base to invest in a widely diversified portfolio of local currency government bonds from the emerging markets. Over time, however, the keener focus on ESG criteria has made investments in emerging markets government bonds increasingly unattractive. This has caused us to change the investment universe.
What is the reason for this complete overhaul of your investment policy? Government bonds hardly play a role anymore. How come?
As a result of our swapping government bonds for bonds issued by supranational issuers, the fund has climbed to the highest echelons of the ESG ranking. Investments in countries that make little progress in implementing and complying with social and environmental standards or that do not meet minimum criteria in areas such as corruption or the rule of law are excluded under the new concept. Instead, we invest in bonds from supranational issuers.
What are bonds from supranational issuers?
Supranational (SSA; sovereign, supranational, and agency) bonds are generally defined as debt securities issued by international institutions or national non-governmental institutions with a public mandate. SSAs have different mandates and geographic focuses and are managed as if they were private but are owned by one or more governments. These institutions generally link their lending with social and political objectives, which are, of course, tied to compliance with ESG criteria. This is how supranational issuers achieve a very high ESG rating, and it is how we were awarded the Austrian Ecolabel. Examples of supranational issuers include the World Bank, the European Investment Bank, and the Asian Development Bank.
IMF forecast: real GDP growth in the most important industrialised and emerging economies from 2023 to 2025 (year-on-year)
Source: IMF; © Statista 2024. Further information: global, 2023 to 2025
Do higher social and environmental standards affect issuers’ credit ratings?
SSA issuers generally have a higher credit quality than corresponding government bonds; they are usually rated AAA or AA. This allows investors to invest in emerging markets currencies by purchasing high-quality securities. In addition to the aforementioned ESG benefits, issues by supranational issuers also come with the advantage of no withholding tax. Also, the Eurobond format may eliminate the need for a local custodian bank.
Apart from the positive classification of the fund, what reasons do you see for investing in emerging markets bonds at this point in time?
At present, emerging markets bonds are supported by a favourable growth and inflation environment. We do not expect the existing signs of a slowdown in the US economy to turn into a recession. At the same time, we envisage a further decline in inflation rates. Although some stabilisation tendencies can be observed in core inflation rates, the disinflation trend should continue. In such a scenario, local currency bonds should benefit in particular.
The beginning of a cycle of interest rate cuts in the USA is another factor with a positive impact on emerging markets bonds. The average yield of the bonds held by ERSTE RESPONSIBLE BOND EM LOCAL is currently 7.54% (source: Erste Asset Management, as of 17 September 2024). However, currency risk must also be taken into account. On that front, many models show that emerging markets currencies are fairly valued or even undervalued. This implies that the expected total return in euro will be clearly positive.
In the run-up to the US elections, there is uncertainty about what economic policy path the world’s largest economy will take after 5 November. Which of the two candidates would be more likely to favour investment in emerging markets as president?
The upcoming US elections could, of course, cause some volatility on the financial markets. A victory for Donald Trump would likely lead to trade barriers such as tariffs. It would negatively affect economic growth and emerging markets currencies. If the current poll leader, Kamala Harris, wins, a continuation of the status quo is likely. In this case, a decline in risk premiums should support local currency bonds from supranational issuers in the emerging markets.
Erste Asset Management: more than 20 years’ experience and certified by the Austrian Ecolabel
The Austrian Ecolabel for sustainable financial products (UZ 49) has existed since 2004. It is the oldest financial label in Europe. There are now (01/2024) 380 certified financial products. The Austrian Ecolabel is a state award. It offers guidance to consumers who want to invest money according to environmental and socio-ethical criteria.
With more than 20 years of experience, Erste Asset Management is one of the pioneers of sustainable investment in Austria. Our funds have been certified by the Austrian Ecolabel since 2006 and can be purchased at Erste Bank and Sparkasse.
Risk notes according to 2011 Austrian Investment Fund Act
In accordance with the fund regulations approved by the Austrian Financial Market Authority, the ERSTE RESPONSIBLE BOND EM LOCAL intends to invest more than 35% of its fund assets in securities and/or money market instruments of member states, local authorities or international organizations under public law. A detailed list of these can be found in the prospectus, section II, point 12.
The fund employs an active investment policy. The assets are selected on a discretionary basis. The fund is oriented towards a benchmark (for licensing reasons, the specific naming of the index used is made in the prospectus (12.) or KID “Ziele”). The composition and performance of the fund can deviate substantially or entirely in a positive or negative direction from that of the benchmark over the short term or long term. The discretionary power of the Management Company is not limited.
For further information on the sustainable focus of ERSTE RESPONSIBLE BOND EM LOCAL as well as on the disclosures in accordance with the Disclosure Regulation (Regulation (EU) 2019/2088) and the Taxonomy Regulation (Regulation (EU) 2020/852), please refer to the current Prospectus, section 12 and the Annex “Sustainability Principles”. In deciding to invest in ERSTE RESPONSIBLE BOND EM LOCAL, consideration should be given to any characteristics or objectives of the ERSTE RESPONSIBLE BOND EM LOCAL as described in the Fund Documents.
Advantages for the investor
- Broad risk diversification through the selection of local currencies from a wide range of emerging markets.
- Supranational issuers and development banks usually have a high credit rating.
- High earnings potential in the long term.
- Opportunity for high annual distributions.
Risks to be considered
- Emerging markets are traditionally subject to high fluctuations.
- Due to the investment in foreign currencies, the fund share may be adversely affected by exchange rate fluctuations.
- Capital loss is possible.
- Risks that may be of significance for the fund are in particular: credit and counterparty risk, liquidity risk, custody risk, derivative risk and operational risk. Comprehensive information on the risks of the fund can be found in the prospectus and the information for investors pursuant to Section 21 AIFMG, Section II, chapter “Risk information”.
Legal note:
Prognoses are no reliable indicator for future performance.
For a glossary of technical terms, please visit this link: Fund Glossary | Erste Asset Management