Country-Level Governance: Next Generation of Responsible Investing in Constructing International Portfolios

June 2016

In Part 1, we highlight the trend of Responsible Investing and its continued growth throughout the world. Just as more corporations are embracing the need to address sustainability issues as a best business practice that can lead to increased profitability, institutional investors are incorporating Environment, Social, and Governance (ESG) and related screening approaches into the construction of their portfolios. The significant and growing share of funds using Responsible Investing reflects improvements which have been made to the screening approaches and in the information available to make the underlying decisions. The improvements to Responsible Investing are also evident in the changing discussion of performance. A shift from “negative screening” that avoids specific non-ESG companies to “positive screening” that overweights ESG-aligned opportunities has begun to demonstrate strong performance. When considering the various approaches to screening companies, an emphasis on corporate governance appears to be very important in achieving Responsible Investing portfolios that outperform.

In Part 2, we observe that company governance is heavily influenced by the legal, regulatory, accounting, and economic systems of a country. These country-level considerations have a significant impact on company valuation. Despite the value of country-level governance information, equity analysts have not incorporated this investment information into their research process. They have been impeded by the obstacles involving its collection, standardization, and use. To make such information viable, analysts require access to methods that support the qualitative analysis of sovereign factors. They also need procedures for standardizing the analytical results.

Sustainable Wealth Creation principles, which are based on widely-accepted economic concepts, overcome previous obstacles to measuring country-level governance. When combined with a new research process based on observable behavior, country-level governance can be measured in an actionable, objective, and repeatable manner.

Finally, in Part 3, we discuss how countries matter, including the country exchange where a company is listed. The Country Selection Technique can be used to build portfolios with country level ETFs. Portfolios built using the Country Selection Technique have delivered outperformance for more than a decade.

In addition, the Country Selection Technique can be used as an overlay to determine the country weightings of an international portfolio where the advisor is buying individual securities. Whether directly used in the construction of portfolios or as an overlay, country-level governance is a powerful and responsible technique of international equity investing.

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