Sustainability Country Rating November 2013

A new tool in the box: Sustainability Country Rating

Sustainability is integrated in four steps into the investment process:

• An industry analysis under sustainability aspects,

• a universe screening and

• portfolio construction where the membership to the universe is – amongst other things – limited by minimum sustainability performance and exclusion factors,

• and the fundamental company valuation in which the sustainability performance or score has an impact on the valuation of a company;

RobecoSAM has now added the Sustainability Country Ranking to the toolbox:

• initially developed for the sovereign bond traders at Robeco;

• It analyzes and ranks 59 countries under sustainability aspects;

• It provides a long-term view to the risks and chances of countries, in addition to the bond-grades provides by the ratings agencies

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Sustainability as an Extension to Sovereign Ratings

Sovereign Ratings as developed by rating agencies (Moody‘s, Fitch, S&P) are

statements on the default-probability of sovereign bonds. As such the ratings

correspond with the (remaining) terms of the bonds.

The capability and willingness of governments to honour their debt is primarily caused

by a) the level of existing debt, and b) the current/new deficit, which depends –

among others - on the position in the economic cycle.

Overall this means, an assessment of abilities of governments to increase tax receipts

or to reduce expenditures.

Hence, the focus of classical sovereign bond ratings is more on short term factors with

a direct impact, and less weight is given to factors whose impact is rather long

term or more indirect.

We subsume those additional long term/more indirect factors under

„sustainability“.

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Conceptual Framework

i) Criteria selection based on plausibility-checks; currently the model contains more than 250 subcriteria/dataseries;

ii) weights are set explicitly in the model and based on our subjective opinion (e.g. 65% for governance criteria, 20% for social, and 15% for environmental criteria);

iii) ranking scores are then calculated for each country;

iv) the validity of the scores is then tested in a regression analysis of scores against the changes in credit default swaps of sovereign bonds.

• The Ranking covers the OECD-countries plus important emerging market countries (currently in total 59 countries).

• New criteria are constantly evaluated.

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Citeria and wheights

Dimension Level Indicator Level Subindicator Level

Environmental Dimension 15% General Environmental Data (5%) Various data series on the atmosphere, water and land

resources, biodiversity

Energy (5%) Various data series on the use and trade of energy and

renewable energies in particular

Environmental Risk (5%) Various data series describing the exposure to

environmental/natural risks and the capabilities to mitigate or

to adapt to risks

Social Dimension 25% Social Indicators (10%) Various data series focusing on education, welfare, world and

equality parameters

Human Development Index (10%) Data series taken fro the UN used to calculate the UN

development index

Strikes and Lockouts (5%) Data taken from the ILO on strikes and lockouts

Governance Dimension 60% Governance - Quality (10%) Various data series on political rights, civil liberties, and

quality parameters on governance

Competitiveness (10%) Various data series taken from the World Economic Forum on

institutions, infrastructure and market efficiencies, and

innovation

Political Risk (10%) Various data series on stability, conflicts and corruption

Governance - Structure (15%) Data taken from the World Bank on the rule of law,

accountability etc.

Ageing (10%) Various data series on ageing, demographic policies and cost

Monetary Policy (5%) Various data series on monetary institutions and policies and

further structural issues

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Results in Excel-Sheets

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Additional Comments:

Version 2 of the Robeco-/RobecoSAM model is now out.

• The better the score, the cheaper and the more stable the CDS-spreads. The Ranking-Scores can explain up to 1/3 of the variations of CDS-spreads.

• As we assume that 1/3 is explainable by the Sovereign-Bond-Rating and another 1/3 by the current position in the economic cycle, the model seems to be robust.

• The high weight of institutional factors shows: Decisive is the ability of governments to react to challenges.

• But: The explanatory power of the scores is low for some developed countries. .... Isn‘t that a surprise when these countries, resp. their central banks, manipulate the capital markets?

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But the rankings may be put into perspective...

France • Gross Debt to GDP: - 100% (2011); -105% (2012)

• Public Deficit to GDP: -5.2% (2011); -4.5% (2102)

• Current Account Balance to GDP: -2.0% (2011); -2.1% (2012)

• S&P Local Currency Rating: AA+ (as of 14.05.2013)

• Since the late 1970s, the general government deficit has always been in deficit. The main cause has

been the sharp rise in public spending, primarily on pensions and healthcare. In 2011 France had the second highest public spending ratio among OECD countries. The share of public employment in total employment was 23%, the highest ratio in the OECD except in Nordic countries. The resulting high level of taxes creates distortions that weigh heavily on the economy.

Insight from the sustainability analysis: France scores weak on indicators related to public governance and on ageing; In spite of its comparatively good demographics, France’s financial problems are caused by huge and rising deficits in its pension and health care system and in the costs of its very large public labor force; It is not clear if the current government has the will and the ability to propose and enforce the necessary cuts in subsidies for the pension and health care system and to reduce the number of public employees;

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... And Switzerland

Switzerland

• Gross Debt to GDP: - 40% (2011); -39% (2012)

• Public Deficit to GDP: +0.5% (2011); +0.7% (2012)

• Current Account Balance to GDP: +10.4% (2011); +11.5% (2012)

• S&P Local Currency Rating: AAA (as of 14.05.2013)

• Capital markets’ concerns regarding sovereign debt in several countries have led the Swiss franc to appreciate to record levels. The SNB has introduced an upper limit on the Euro/Swiss franc exchange rate to stop appreciation. While keeping interest rates low for some time is appropriate, unusually low interest rates have boosted mortgage lending and house prices. Switzerland is running the risk of importing asset price inflation.

Insight from the sustainability analysis: Switzerland is a top country both in financial terms and with regard to sustainability; The only significant weakness in Switzerland’s sustainability profile lies in the ageing of its population; So far this risk has mostly been mitigated by immigration; As further immigration may face acceptance-problems in the Swiss population, it may be necessary to increase the financial reserves for age-related future spending (and to convince its own population to invest more in its own families);

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