In the past, investors often balked at the idea of applying environmental, social and governance (ESG) criteria when investing in emerging markets. We believe such an attitude is based on outdated associations of low income with political, social or economic disadvantages. Many EM countries have undergone significant progress and now have middle-income status.
Looking ahead, some of the poorest countries with the lowest ESG scores may, in fact, have the potential to show the biggest improvements in environmental efficiencies, social good and governance. These are also the countries most in need of long-term responsible investment to bolster a growing middle class through economic growth and job creation. The resulting increase in demand for consumer goods, infrastructure, services and agri-business can benefit patient investors.
Motivating policymakers to do the right thing
Today’s emerging market landscape presents a mix of countries at different stages of development. Some are evolving in a positive direction as living standards, policy frameworks and democracy improve; others are regressing in terms of policy trajectories and quality-of-life factors.
Against this backdrop, an ESG framework involves a forward-looking view on long-term success that sends a clear signal to EM countries of investors’ focus on sustainability.
In short, there are two ways for investors to generate alpha: either overweighting the champions or underweighting the pitfalls. So, EM investing is not just about finding the best markets; it is also about avoiding the worst ones.
Long-term sustainability, we believe, is synonymous with minimising the potential for ‘blow-ups’. These are, arguably, harder to predict. Furthermore, we cannot rely on past cycles and back-testing; instead, we need a view on what is likely to happen.
At the same time, asset owners and other investors increasingly expect fund managers to have ESG lenses. And this desire for tailored investing is driving a more innovative and nuanced implementation of ESG research.
Adding value with an ESG tilt
We see three key reasons why ESG factors are important in portfolio construction:
- Evidence that an ESG screen generates additional performance – for example, we are overweight the Dominican Republic and underweight Mongolia
- The ability to (more likely) avoid ‘blow-ups’ when a country reneges on debt obligations – such as with Mozambique, Venezuela and Republic of Congo
- The comfort for investors from doing well by doing good – with knowledge that their investments provide finance for long-term, sustainable growth where it is most needed.
A sustainable process
Our ethos of responsibility involves investing for the future and taking a stand on the implications of our enterprise and long-term viability of our holdings. The emergence of ESG investing is not a trend we ride, but one we embrace.
Within the 90 EM countries we invest in, we aim to educate our clients on ESG issues to trigger greater awareness from a nuanced, considered approach to an exciting asset class.
Our sovereign debt ESG model
- assesses governments’ efforts to convert their level of economic development into positive environmental, social and institutional outcomes
- evaluates whether their ambition to address climate change is sufficient to meet the goals of the Paris Agreement.
It draws upon insights from quantitative modelling, qualitative analysis, our sovereign bond investment centres and from our interactions with regulators and policymakers.
Ultimately, rather than inclusion or exclusion, we apply a score to determine the size of the holdings in our portfolios, leading us to overweight high ESG countries and curb our investments in low ones.
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Any views expressed here are those of the authors as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
Read more about our Global Sustainability Strategy
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.