How insights into economic transparency can generate alpha for clients

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By Marshall L. Stocker, Ph.D., CFACo-Director, Portfolio Manager Emerging Markets Team, Eaton Vance Management

Boston - "Economic transparency" may not be a concept that many investors have dwelled on. Attributes that form the foundation of all free markets — like timely and reliable access to fiscal, monetary and economic data — are generally taken for granted in most advanced economies.

But in fact, economic transparency varies widely across countries, especially among developing markets. The Eaton Vance emerging markets team believes that for every country, identifying and quantifying the crucial components of economic transparency are important tools for generating alpha. Further, we seek to use this knowledge in the broader context of advocacy for environmental, social and governance (ESG) issues — an effort that we believe can benefit governments, issuers and investors alike.

New research from our team, "Economic Transparency means a creditworthy sovereign,"1 advances the literature on the subject and introduces a proprietary Economic Transparency Index that ranks 130 countries on a wide variety of metrics. These include budget balance, public debt, consumer prices (CPI), external debt, employment, wage growth, exports and inflation, as well as commentary and updates from the central bank, parliament, ministry of finance and statistical agencies.

Each metric is ranked from zero to four based on periodicity and timeliness, as noted in the table below, and countries are ranked based on these scores. For example, ministries of finance are expected to report on budget balance every 30 days, and central banks should be reporting on consumer and producer prices every 21 days. Statistical agencies, such as the U.S. Bureau of Labor Statistics, should be reporting on indicators like employment and wage growth every 45 days.

Grading economic transparency


Source: Stocker, M., E. Thornton, P. Tan, "Economic Transparency means a creditworthy sovereign," Eaton Vance white paper, May 2021.

Organizations like the IMF, World Bank and OECD also publish transparency indexes, but we have sought to improve the breadth, depth and timeliness of the process in a number of ways. For instance, the Eaton Vance Economic Transparency Index covers a wider scope of countries and a greater number of variables (e.g., central bank and fiscal policy), and is planned to be updated on an annual basis with a shorter lag time.

Confirming the benefits of transparency

Our research sought to confirm that the market rewards the issues of countries that rank higher on our Index. With sovereign debt, for example, issuers higher up on the Index should trade at tighter spreads and have higher credit quality ratings than lower-ranked countries.

As the chart illustrates, our regression analyses confirmed the relationships: Greater transparency meant issues traded at tighter spreads and received higher credit quality ratings. The analyses used a matrix of control variables to make "apples-to-apples" comparisons among countries, taking into account metrics such as GDP, economic freedom, reserve levels and so forth. With the control variables, the findings are statistically significant at the 95% level.

As economic transparency increases, spreads tighten and credit ratings improve

Source: Stocker, M., E. Thornton, P. Tan, "Economic Transparency means a creditworthy sovereign," Eaton Vance white paper, May 2021.

Germany was found to be the highest ranked in economic transparency, but the top two deciles had significant representation from developing countries — Lithuania, Ukraine and Armenia came in second, third and fourth, respectively; Georgia ranked seventh, which was good enough to top the ninth-place finish of the U.S. Some other surprising contrasts showed Russia near the bottom of the top half but ahead of Hong Kong. Turkey, Bulgaria and Pakistan also ranked above median and also ahead of Japan. Saudi Arabia and China were near the top of the bottom half but ahead of Denmark.

We believe that using economic transparency metrics to forecast likely asset valuation changes in real time will help us generate alpha for our clients. Moreover, we believe the "edge" gained in this process can persist because the data collection and scoring are a laborious, manual effort requiring in-depth examination of hundreds of governmental publications. We have seen few peers willing to commit the kind of time, resources and expertise necessary for comparable research.

We have started to use the findings presented here as the basis of our ESG engagement with policymakers. We expect a positive reception for evidence that shows how pursuing greater economic transparency could lower a country's borrowing costs and improve its credit ratings.

Bottom line: We believe that greater awareness of the virtues of economic transparency can benefit governments, issuers and investors alike. The Eaton Vance emerging markets team plans to continue using such insights to seek value for our clients.

1 Stocker, M., E. Thornton, P. Tan, "Economic Transparency means a creditworthy sovereign," Eaton Vance white paper, May 2021.