The traditional risks associated with fixed income investing are well known and include, among others, interest rate risk, reinvestment risk, inflation risk and credit risk. What varies from analyst to analyst and from fixed income asset class to fixed income asset class is the precise weight placed on each of these factors. For example, credit risk is a much more relevant consideration for investments in high yield corporate debt than in US treasuries.
Traditionally, credit risk is assessed through the use of ratios that are designed to measure the debt burden and cash flow profile of sovereign and corporate issuers. Ratios, however, only tell part of the story. Investment in sovereign fixed income assets is subject to risks uncaptured by traditional credit analysis, including willingness to pay, environmental capacity constraints and social stability. Particularly over the longer term, we believe that these factors are highly relevant to the performance of financial market assets and should be key areas of consideration during the risk assessment process. In order to account for these more subjective but vitally important risk factors on a standardized basis we at Standish have developed a proprietary Environmental, Social and Governance (ESG) rating model for sovereign issuers. The Standish Sovereign ESG Rating Model will allow us to quantify the ESG risk profile of Sovereign issuers and incorporate this information into our assessment of overall credit risk. Ultimately, this will provide a more comprehensive assessment of the risks associated with a given investment and should contribute to better risk adjusted excess return.