Sustainable, Responsible &/or ESG Policy:

Constructing a sustainably-aligned sovereign portfolio starts with a comprehensive bottom-up approach and requires a thorough country-by-country assessment. At Aegon AM, we base our sustainability methodology on the works of the Bertelsmann-Stiftung and Sustainable Development Solutions Network (SDSN) partnership, sponsored by the United Nations. Our transparent scoring methodology builds on this independent and credible framework and leverages reliable data sources. By using more than 100 indicators per country we have built an SDG scoring methodology that allows us to reflect our views on sustainability on 172 countries worldwide.

In addition to the sustainability country assessment, fundamental analysis is a vital part of our analysis. The portfolio construction stage includes conventional sovereign analysis, bringing together the strength of fundamentals (such as current macroeconomic conditions), valuations (including fair value versus market price), qualitative inputs (such as sentiment indicators and market positioning), and technicals (including price behavior or volumes). Active management is key for any sovereign portfolio as sustainability assessments are typically not directly linked to a country’s economic performance and a long term investment horizon is very important in achieving expected results.

We exclude investments in any form of government-issued debt (e.g., government bonds) from countries that systematically breach human rights or from a country whose government is subject to an arms embargo by the United Nations Security Council, the United States, the European Union or another relevant multilateral arms embargo.

Process:

We only invest in a pre-defined investment universe consisting of the most sustainable countries. This universe is based on a robust process that includes a proprietary country analysis methodology, combined with a formal approval process by a sustainable investment committee. Our methodology tracks more than 100 key performance indicators per country worldwide, focusing on the key issues that challenge sustainable development at an issuer level.

Features of our methodology include:

• A proprietary, unique way of looking at sovereigns based on the works of Bertelsmann-Stiftung and Sustainable Development Solutions Network (SSDN) partnership, sponsored by the United Nations.
• Covering 172 countries in the world, +100 indicators per issuer retrieved from independent sources.
• Information on overall scores and individual subcomponents, customized per country.
• Recognizing key differences across countries and their performance vs peers.

Our country selection analysis begins with the identification of sustainable sovereign issuers. We define a sustainable sovereign issuer as a country that is making substantial progress towards achieving the UN SDGs as a result of good policy, and whose government is able to manage risks to sustainable development.

Countries have to be classified into one of five sustainability categories:

• Leader: The country has already achieved critical SDGs and is on track to achieve others. Leaders show outstanding commitment to increase or maintain their sustainability performance. Leaders do not have sustainability risk or controversial policies.
• Influencer: The country is on track to achieve some SDGs and exhibits a clear commitment to sustainability. Influencers have limited sustainability risk and no major controversial policies.
• Improver: The country demonstrates an above average performance as compared to its development peers, but still faces significant challenges in terms of SDG achievements. Improvers have sustainability risk but continue to deliver a credible promise through policy or other means to tackle its potential controversies.
• Neutral: The country is not on track to achieve most SDGs, shows no significant improvements in its sustainability performance and seems to have no clear ambition to do so in the future. Neutral’s have sustainability risk with controversies that require monitoring.
• Detrimental: Country is not on track to achieve the SDGs, and has no intention of doing so. Detrimentals have the highest sustainability risk, with possible major controversies.

In order to evaluate and compare sustainability goals between countries and classify countries into different categories, we include qualitative and qualitative considerations in our country assessment.

Quantitative factors

• Sustainability scores: measure performance of a country on a standalone basis to help assess how far/close a country is achieving a specific SDG.
• Relative sustainability performance: measure performance versus a country’s peer group in dimensions like income or region. This comparison helps us identify leaders and laggards.
• Sustainability momentum: to assess the developments over time in scores due to policies applied in the past.

Qualitative factors

• SDG achievement: Interpret the data, qualify, clarify, and complement what was shown during the quantitative assessment. Identify the drivers behind the numbers and estimate what can be expected in the future given the current policies.
• Sustainability risk: Aims to identify any risk to a country’s sustainability performance. At this stage, the materiality of those risks to the financial profile of the sovereign is not yet considered.

Country profiles must be formally approved by the firm’s Sustainability Investment Committee. This committee consists of members of the responsible investment team and the rates & money markets team, and convenes on a monthly basis to evaluate issuers. Ad-hoc meetings are organized whenever current circumstances may require a review of a country’s sustainability profile. At a minimum, issuers are re-evaluated annually.

After evaluating this information, individual members of the committee must vote to reach consensus on the final classification. The sustainability assessment defines the investable universe; only issuers classified as ‘leaders‘, ‘influencers‘ or ‘improvers‘ are eligible for investment. As a consequence, the portfolio will not invest in countries considered not sustainable (i.e. ‘neutral’, or ‘detrimental’).

After the investable universe has been defined, we will apply our regular process for bond selection by identifying attractive points on the curve, evaluating price anomalies, finding attractive new issues or using technical indicators, and integrating ESG factors, similar to what we do with our regular government bond portfolios. Countries in the portfolio combine strong fundamentals and a high ambition to tackle the sustainability challenges as defined by the United Nations. Within this context we evaluate individual issuers and their bonds based on:

• Relative value analysis: issuers’ interest rate curves are compared in order to identify which of a country’s bonds offer better value for the amount of duration assumed. The same assessment applies to new bonds issued in the primary market, that typically include a new issue premium. Issuers are assessed using our quadrant approach, which brings structure and discipline to our research process. Each bond is analyzed based on four equally weighted dimensions: fundamentals (economic cycle and current monetary policy stance), qualitative/sentiment (risk aversion and investor sentiment), technical (volume analysis and new issuance), and valuation factors (current pricing of a bond against its fair value). Other relevant aspects of relative value analysis could be (but not limited to) carry and roll analysis, real yield analysis, and other macroeconomic comparisons such as issuance needs, etc.
• ESG considerations: non-financial material issues can have an impact on the decision to invest or divest in a bond, or adjust a bond’s portfolio weight. We aim to identify those bonds that have the potential to impact an issuer’s creditworthiness in the long run, and that may result in credit rating upgrades (or downgrades).
• Climate alignment: climate KPIs (such as GHG, CO2 emissions per GDP or CO2 emissions per capita) are used to prioritize investments. All else equal (for example, when the expected returns of an investment for the amount of risk assumed is similar), issuers with a better climate alignment profile are preferred.

Changes in fundamentals and sustainability metrics can trigger a portfolio rebalancing. Sustainability and market risks are monitored on an ongoing basis by investment team, whereas the Sustainable Investment Committee periodically reviews the sustainability adequacy of the portfolio.

In carrying out research and to generate investment ideas, the portfolio managers screen local and international news sources, official publications on monetary and fiscal policy, reports from rating agencies like Fitch or Moody’s and from a number of different banks and brokers. Macroeconomic research aids the investment team’s decision making regarding the portfolio’s exposure to systematic risk factors. The responsibility for ESG research lies with our sovereign analysts, and is supported by members of our responsible investment team.