Environmental, social and corporate governance, or ESG, is a hot topic in the investment world. While it is unavoidable in developed markets, both as an investment approach for asset managers and as something companies need to have at the heart of their business models, emerging markets have been a little slower to adapt.
“ESG integration is becoming the norm for most asset management houses, at least in Europe, which means it does apply to every single team,” says Mathieu Negre, head of global emerging equities at UBP. Emerging markets teams, in equity or fixed income, may not be at the forefront of that but they are following it, he explains.
Because of the higher dispersion of governance practices and regulatory environments found in emerging markets, investors allocating to these regions, and particularly those with a quality bias, have been paying attention to governance issues for a long time, says Mr Negre. “So some feel they are quite happy to move to ESG because they have been doing something quite similar for a number of years.”
Bit of a lag
In terms of the companies themselves, the picture is a little more mixed, he says. Whereas you would be hard pressed to find a listed company which had nothing to say about ESG, there are still those in emerging markets who claim to be aware of the approach, but have yet to take any specific action, reports Mr Negre.
“So I think it is fair to say there is a lag when it comes to ESG in emerging markets, as compared to the developed world, although the direction of travel is the same,” he adds.
For example, the general standard of sustainability reporting is a notch below what is to be found in more advanced markets, particularly Western Europe, says Mr Negre. “That is due in part to local regulations, but also because of what investors expect.”
However, some markets are very good on the issue, he says, giving the examples of South Africa, Brazil, and Chilean companies, where sustainability reporting is generally high.
Nothing new
Governance has been an issue in emerging markets for quite a while already, says Jeffrey Sacks, Emea Investment Strategist at Citi Private Bank, and for reasons unrelated to ESG.
“Go back a decade, and governance and transparency were particularly poor, and emerging countries with companies within them who needed to raise capital from overseas investors needed to raise levels of governance and transparency to do that.”
This has been accelerated by the global trend towards ESG, he explains. “And the bigger emerging market companies are now large-cap global players, they are now talking to sophisticated overseas investors who are demanding high-ESG standards. And of course the trickle down to mid-caps looking to grow will have to follow that path.”
Changing tone
Company engagement is a crucial part of emerging market investing, says Chetan Sehgal, lead portfolio manager at Templeton Emerging Markets Investment Trust. He claims that bringing about better corporate behaviour and a better understanding of companies’ responsibilities toward all stakeholders are efforts the firm pushes in its stewardship of client capital.
“The tone of engagement in emerging markets has shifted: companies that formerly took a narrow, hard-nosed approach to returns are adopting more accommodative measures,” reports Mr Sehgal.
In countries such as South Korea, companies are placing more emphasis on ESG issues, he says. “We have seen leading companies in South Korea publicly apologize for governance missteps and manage their balance sheets more effectively through returning capital to shareholders. In India, companies are required to spend a certain portion of their profits on social activities. ESG reporting has become mandatory in some countries: a trend we expect to continue elsewhere.”
The ESG conversation is changing further amid the Covid-19 pandemic, with a greater focus on the social impact of policies, says Mr Sehgal.
“Many governments are supporting jobs, while companies are more cognisant of the reputational risks of layoffs. ESG has become more important, with companies considering it critical to sustainable business performance. In our view, this ‘delta’ of improving ESG in emerging markets is a further tailwind supporting the secular outlook for the asset class as the world emerges from this crisis.”
The victory of Joe Biden in the US presidential election should only serve to accelerate the trend towards ESG, given that his predecessor, Donald Trump, was hardly a cheerleader for anything environmental. That said, there is an argument that the momentum behind these types of strategies has not abated despite the Trump administration, says UBP’s Mr Negre.
“Investors have continued to move towards this trend despite that, so you do not always need federal regulation to improve things on the ground. Awareness around climate change and so on has increased and companies are deciding to integrate ESG nonetheless.”
Nonetheless, victory for Mr Biden should be positive for ESG in the US. “We don’t need a green new deal necessarily, but some of the headwinds would stop for companies based there.”
