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FRANKLIN TEMPLETON THINKSTM GLOBAL MACRO VIEWS

An update on our ESG scores

2 Global Macros Views / An update on our ESG scores

In this Issue

In February 2018, Templeton Global Macro (TGM) published Global Macro Shifts issue 9—Environmental, Social and Governance Factors in Global Macro Investing [GMS-9]. The paper explored how we evaluate environmental, social and governance (ESG) factors in our macroeconomic research process, and described the process of codifying the team’s research discussions into quantifiable scores. GMS-9 formally introduced our proprietary ESG scoring system, the Templeton Global Macro ESG Index (TGM-ESGI). Going forward, we intend to publicly update our scores on a recur-ring basis. This paper is the first of these updates. It contains a brief background on our ESG philosophy and our scoring process, along with updated TGM-ESGI scores for 56 countries. We also include brief case studies for three countries that have improving projected scores and three countries with deteriorating projected scores.

TGM’s ESG Philosophy and process

Before delving into the specific scores, we would like to summarize a few key points on how TGM views our internal ESG process. These points also reflect how TGM believes ESG can be best utilized by investors in the sovereign space.

1. ESG is most effective when fully integrated into the other components of research, including traditional economic analysis and on-the-ground visits. These issues contribute to core macroeconomic views on a country. ESG factors are then expressed through analysis of economic issues such as growth and inflation.

2. We focus on forward-looking data points. Rather than current ESG performance, which is strongly correlated with income levels, TGM believes that momentum, or change in score, is the measure that truly matters for both potential investment performance and for determining where capital could be deployed for the greatest positive impact.

3. ESG is an important tool for identi-fying investment opportunities in addition to highlighting areas of risk. TGM is most interested in the “tails” signaling major ESG shifts in either direction.

4. In order to benefit from ESG analysis, investors must have a sufficiently long time horizon.

ESG factors guide a country’s fundamentals, which can be over-shadowed in the short term by cyclical or temporary conditions. We believe conviction in the view and patience to see that view come to fruition are requisites to successful ESG investing.

5. Emphasis on a country’s long-term fundamentals provides an effective base for TGM to open communica-tion with policymakers interested in discussing best economic prac-tices. This dialogue is important for our ability to serve clients, and for government officials interested in the perspectives of private markets.

Global Macros Views / An update on our ESG scores 3

The TGM-ESGI is a composite of 13 subcategories (see GMS-9, page 4) determined to be material to macroeco-nomic performance, scored from 0–100.1 The research team assigns numbers by overlaying their views on a benchmark created by global indexes for current scores. Analysts then provide projected numbers in anticipation of

how conditions will change in the medium term. The final scores are calculated with weightings of 40% for governance, 40% for social and 20% for environment. The environment receives a lower weighting because its effects on macroeconomic performance take place over a significantly

longer-term time horizon. The change in score, the metric TGM places the greatest emphasis on, is simply the projected score minus the current score.

The results from our February 2019 scoring are shown in Exhibits 1 and 2. We have expanded the number of countries to 56 from 44 previously.

TGM-ESGI: Methodology and scores

ENVIRONMENTAL, SOCIAL AND GOVERNANCE SCORES BY COUNTRY (TGM-ESGI)Exhibit 1: TGM-ESGI Scores: CurrentAs of February 2019

80

60

40

20

0

100TGM-ESGI Score

Vene

zuel

aNi

geria

Tanz

ania

Ecua

dor

Keny

aEg

ypt

Zam

bia

Ukra

ine

Phili

ppin

esIn

done

sia

Sri L

anka

Ugan

daIn

dia

Ghan

aBr

azil

Russ

iaTu

rkey

Viet

nam

Colo

mbi

aGr

eece

Peru

Mex

ico

Sout

h Af

rica

Arge

ntin

aCh

ina

Serb

iaTh

aila

ndUr

ugua

yCr

oatia

Chile

Italy

Mal

aysi

aHu

ngar

yPo

land

Slov

akia

Lith

uani

aSp

ain

Port

ugal

Kore

aIs

rael

Fran

ceJa

pan

Czec

h Re

publ

ic UKNe

ther

land

sIr

elan

dGe

rman

yAu

stra

liaNe

w Ze

alan

d USSw

eden

Norw

aySi

ngap

ore

Switz

erla

ndCa

nada

Denm

ark

Exhibit 2: TGM-ESGI Scores: Projected ChangeAs of February 2019

8

6

4

2

0

-2

-4

-6

10

Source: Calculations by Franklin Templeton Capital Market Insights Group using data sourced from Bloomberg, Central Bank News.

Pola

ndIta

ly USVe

nezu

ela

Hung

ary

Turk

eyCz

ech

Repu

blic

Sing

apor

eSo

uth

Afric

aSp

ain

Germ

any

Chin

a UKRu

ssia

Tanz

ania

Ugan

daSr

i Lan

kaJa

pan

Neth

erla

nds

Isra

elSw

eden

Nige

riaFr

ance

Kore

aUk

rain

eM

alay

sia

Zam

bia

Croa

tiaLi

thua

nia

Slov

akia

Switz

erla

ndDe

nmar

kNo

rway

Urug

uay

Mex

ico

New

Zeal

and

Aust

ralia

Cana

daPh

ilipp

ines

Irel

and

Port

ugal

Keny

aEc

uado

rVi

etna

mGr

eece

Egyp

tCh

ileCo

lom

bia

Thai

land

Ghan

aPe

ruIn

done

sia

Serb

iaIn

dia

Braz

ilAr

gent

ina

TGM-ESGI Score

1. The scale has been expanded to 0–100 from 0–10 since the methodology’s original publication.


Three Countries with Improving Projected ESG Scores

Brazil• Recent elections in Brazil represent a new direction for

the country, including a firm rejection of systemic corruption under ex-President Luiz Inacio Lula da Silva and the Workers Party (PT). The cleanup of Lava Jato— a corruption scandal also known as Operation Car Wash—and public enthusiasm for its efforts has empow-ered the judiciary to launch a campaign against graft.

• The administration has assembled a capable economic team that is intent on addressing fundamental challenges facing Brazil, notably social security reform.

• The business climate in Brazil is expected to improve significantly with reduced red tape and corruption, along with the administration’s push for the privatization of state-owned enterprises and reduction of trade barriers.

• We are cautious of potential deterioration in certain ESG factors due to the current administration’s inclinations, paying particular attention to institutional strength, social cohesion and unsustainable practices.

Indonesia• President Joko Widodo looks poised to win a second term,

reflecting public support for his reform agenda and rejecting the elite background and nationalistic rhetoric of his rival, Prabowo Subianto.

• We expect further progress on president Widodo’s reform agenda following elections. This includes building infra-structure, reducing regulations on businesses and fighting corruption. There will also likely be an emphasis on reducing poverty and inequality.

• Economic management has become increasingly orthodox, with an emphasis on prudent budgets and consistent monetary policy. The number and quality of technocrats within the administration have strengthened.

• Social cohesion in Indonesia is expected to deteriorate with the rise of fundamental Islamic groups and their greater influence over politics.

Case studiesAs stated earlier, what TGM pays greatest attention to are the “tails,” countries in which there is a drastic change with regards to projected ESG scores in either direction. We have highlighted six of these countries, three showing projected improvement and three showing expected deterioration.

Source: TGM-ESGI. Our medium-term projections are for the next three years.

Governance Social Environment

Current Projected

70

60

50

40

30

20

10

0

80

BRAZILExhibit 4: Brazil: Current and Projected Conditions (TGM-ESGI)As of February 2019

TGM-ESGI Score

44

54

36 36

72.2 72.2

70

60

50

40

30

20

10

0

80

INDONESIAExhibit 3: Indonesia: Current and Projected Conditions (TGM-ESGI)As of February 2019



Current Projected

TGM-ESGI Score

4652

44 44

30 30




Current Projected

70

60

50

40

30

20

10

0

80

ARGENTINAExhibit 5: Argentina: Current and Projected Conditions (TGM-ESGI)As of February 2019

TGM-ESGI Score

50

66

4851

73.3 76.7

Argentina• Argentina has maintained commitment to politically chal-

lenging but necessary reforms in order to rebalance its economy. Decisions to float the exchange rate, enact pension reform and reduce subsidies have caused short-term economic pain but are critical to the country’s long-term potential.

• Despite a tougher economic environment, including reces-sion and high inflation, President Mauricio Macri’s government has continued to navigate Congress and pursue orthodox economic policy, including passing a balanced primary budget for 2019.

• President Macri and his Cambiemos party have retained core public support. We continue to expect a Cambiemos victory in the October presidential elections on this base and the split in the Peronist party, but are carefully moni-toring developments.

• The government has moved to rectify many of the previous administration’s corrupt practices by publishing accurate economic statistics and punishing corporations that engage in graft with public officials.

• Energy security in Argentina is expected to improve as a free-floating currency will encourage investment within the natural gas industry, reducing the country’s reliance on expensive imports.

Three Countries with Deteriorating Projected ESG Scores

Italy• Elections in March 2018 cemented populist leadership

with unprecedented victories by the League and the Five Star Movement, bringing Italy into the growing ranks of euroskeptic countries within the European Union (EU).

• The new government stands for populist measures such as tax cuts, anti-immigration efforts and the abolishment of pension reform. These policies, while popular, are counter-productive in the face of Italy’s challenges with high debt levels and low productivity growth.

• Italy is set up for increasing conflict with Brussels as its government seeks less EU oversight into its domestic affairs. While the first major clash, on the 2019 budget, was resolved, we can expect further confrontations down the road.

• Social discord and support for hard-right parties can only be expected to increase as both Italian and broader euro area growth are slowing.



Current Projected

70

60

50

40

30

20

10

0

80

ITALYExhibit 6: Italy: Current and Projected Conditions (TGM-ESGI)As of February 2019

TGM-ESGI Score

6660

5753

75.6 75.7


Turkey• Institutions have been broadly weakened under the execu-

tive presidency, including abolishment of the office of prime minister, the right to dismiss senior civil servants and the ability to appoint judges.

• The numerous purges since 2015 have dismissed tens of thousands of individuals from the civil service, military, judiciary, media and academia—intimidating and severely damaging the capacity of those institutions.

• Economic policies have consistently been misguided, including the erosion of central bank independence and over-extension of credit. Government spending has also been pro-cyclical, concentrated in construction and defense, adding to the overheating.

• Volatile political and economic conditions in Turkey have eroded its credibility among foreign investors. Escalating tensions with the US and European countries will also likely have negative impacts on Turkey’s attractiveness as an investment destination.

South Africa• Economic fundamentals are gradually deteriorating,

including poor fiscal management and deindustrialization in the face of increasing reliance on commodities. The government does not have sufficient political capital to engage in an orthodox reform agenda.

• Low growth and significant inequality have caused greater public demand for redistribution rather than growth. An example is the debate over land expropriation without compensation. This leaning toward populism has damaged business confidence, which has been on a declining trend.

• The African National Congress (ANC) continues to battle factionalism between the supporters of President Cyril Ramaphosa and ex-President Jacob Zuma. This is particu-larly damaging to administrative effectiveness as the ANC governs by collective policymaking. There are also significant tensions between the ANC and its coalition partners, SACP and Cosatu.

• The Ramaphosa administration has worked to fight corruption and graft. The government has turned over the heads of the state security agency and the Hawks, a specialist anticorruption police unit, and dismantled the Gupta empire.



Current Projected

70

60

50

40

30

20

10

0

80

TURKEYExhibit 7: Turkey: Current and Projected Conditions (TGM-ESGI)As of February 2019

TGM-ESGI Score

56

48 44 44 45.6 45.6



Current Projected

70

60

50

40

30

20

10

0

80

SOUTH AFRICAExhibit 8: South Africa: Current and Projected Conditions (TGM-ESGI)As of February 2019

TGM-ESGI Score

6056

44 44

57.8 57.8


WHAT ARE THE RISKS?

This material reflects the analysis and opinions of the authors as at 15 February 2019 and may differ from the opin-ions of other portfolio managers, investment teams or platforms at Franklin Templeton Investments. It is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solici-tation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.

The views expressed and the comments, opinions and analyses are rendered as at the publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market, industry or strategy.

All investments involve risks, including possible loss of principal. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline.

Michael Hasenstab, Ph.D. Executive Vice President, Portfolio Manager, Chief Investment Officer

Templeton Global Macro

Shlomi Kramer, Ph.D. Senior Global Macro & Research Analyst


Calvin Ho, Ph.D. Senior Vice President, Portfolio Manager, Director of Research


Vivian Guo Research Analyst


Hyung C. Shin, Ph.D.Vice President, Senior Global Macro & Research Analyst


Diego Valderrama, Ph.D.Senior Global Macro & Research Analyst


Attila Korpos, Ph.D.Senior Global Macro & Research Analyst


Primary contributors to this issue

Global Macro Views is a complementary publication that will update and/or amplify the periodic research-based briefing on global economies called Global Macro Shifts. Both feature the analysis and views of Dr. Michael Hasenstab and senior members of Templeton Global Macro. This economic team, trained in some of the leading universities in the world, integrates global macroeconomic analysis with in-depth country research to help identify long-term imbalances that translate to investment opportunities.

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This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not consti-tute legal or tax advice.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton Invest-ments (“FTI”) has not independently verifi ed, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user.

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An update on our ESG scores - franklintempleton.lu · his rival, Prabowo Subianto. • We expect...

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