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How to use ESG to assess state government bonds

Pendal’s ESG scorecard measures credit risk on state government bonds. MURRAY ACKMAN explains how it works

IF you’re investing in state government bonds, you’re probably not too worried about default.

But you might be concerned about a potential credit downgrade – which could result in lower demand for a bond and a drop in its value.

Pendal’s income and fixed interest team has a tool to assess the ESG credentials of state governments – which can help highlight credit risks that might lead to ratings downgrades.

The Australian States SDG Index assesses how each state is addressing the UN’s Sustainable Development Goals – a list of the world’s biggest problems.

The ACT, Tasmania and South Australia lead the index, while Western Australia, Queensland and the Northern Territory lag, says Pendal ESG credit analyst Murray Ackman.

“People always talk about default — the risk of not getting your money back,” says Ackman.

Find out about

Regnan Credit Impact Trust

“But that’s not all we’re looking at.

“There would have to be something catastrophic for a state government not being able to service its debt.

“What does have an impact on your investment is credit downgrades.”

How it works

The index scores the states on 70 indicators across 16 environmental and social themes.

It assesses how states perform on factors like healthcare and education spending, climate action, water and sanitation and justice and strong institutions.

Ackman uses the example of ratings agencies downgrading Queensland more than a decade ago after it slid into deficit on the back of a big spending program on water security.

“There was a longstanding underspend on water security, so a lot of money had to be spent on a desalination plant. ESG can give us an early warning sign of these kind of issues.”

Today, Ackman says there are signs of underspending in Victoria on health and well-being and in the Northern Territory on justice and strong institutions.

These could flag future problems, he says.

On the upside, the index shows strong environmental scores in the ACT and Tasmania, both already using a high proportion of renewable energy which reduces the risk of the energy transition.

Ackman says ESG scoring also provides an opportunity to engage with governments and seek to directly drive change — even although governments can be less responsive than corporations to the views of the investment community.

“Engaging with a company can be pretty obvious — one has better human rights policies, another might have good oversight of their supply chain and slavery. You can compare the two and make a decision to engage or divest.

“But government bonds are different. Commonwealth government bonds are more than half the index for some of our fixed interest funds.

“We can engage — and we’re pushing for green issuance and we want to see new projects being funded — but we don’t realistically have the opportunity to divest. Having genuine influence over an issuer would require being willing to walk away.”

He says Pendal’s ESG scoring also allows investors to be sure their money is being invested in line with their intentions.

“Our investors want their values reflected in the investment decisions that we make.”

About Murray Ackman and Pendal’s Income and Fixed Interest boutique

Credit ESG analyst Murray Ackman joined Pendal’s Income and Fixed Interest team in 2020 to provide fundamental credit analysis and integrate Environmental, Social and Governance factors across credit funds.

Murray has worked as a consultant measuring ESG for family offices and private equity firms and was a Research Fellow at the Institute for Economics and Peace where he led research on the United Nations Sustainable Development Goals.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team’s awards include Lonsec’s Active Fixed Income Fund of the Year (2022) and Zenith’s Australian Fixed Interest Manager of the Year (2020).

Regnan Credit Impact Trust is an investment strategy that puts capital to work for positive change.

Pendal Sustainable Australian Fixed Interest Fund is an Aussie bond fund that aims to outperform its benchmark while targeting environmental and social outcomes via a portion of its holdings.

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at February 15, 2023. PFSL is the responsible entity and issuer of units in the Regnan Credit Impact Trust (Trust) ARSN: 638 304 220 and Pendal Sustainable Australian Fixed Interest Fund (Fund) ARSN: 612 664 730. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund and Trust are available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or Trust or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

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