Emerging markets a dilemma for SRI advocates

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There’s an inherent tension between sustainable investing and emerging markets.

While no-one can deny emerging market countries the growth opportunities that have fueled economies in developed countries, the speed of that growth can be problematic. In worst-case scenarios, corporate governance standards are by-passed, natural resources are depleted at an alarming rate and workers toil in poor conditions for low wages.

Just how sustainable is that kind of growth? It’s a dilemma for all investors, particularly those who follow a sustainable or responsible investing agenda.

“If you’re looking at emerging markets, the first point to note is that all investments have some direct or indirect exposure to emerging markets,” says Danyelle Guyatt, head of research for responsible investment at investment management firm Mercer. Indeed, the MSCI World Index, often used as a benchmark for global stock mutual funds, currently has about 12% exposure to emerging markets, he notes.

“By getting on top of sustainability issues, you’re managing embedded risk that already exists in your portfolio,” she says. “So purely from a risk-managed perspective, it makes sense to think and evaluate investment against environmental, social and governance (ESG) criteria.”

It’s a concept gaining traction in emerging markets, notes Bob Mann, managing director of North American operations at Jantzi-Sustainalytics, a Toronto-based research firm specializing in responsible investment.

“The good news is that there is a large focus, both from outside and within emerging market countries, on increasing the level of transparency of companies and their reporting,” Mann says. “The notion of responsible investing is taking off in a number of those countries, such as Brazil and South Korea.”

Minding the gaps Still, numerous challenges remain in what is still a nascent market. The single largest roadblock appears to be lack of data.

“Getting good information on emerging market companies is really difficult,” Mann confirms. “If you’re a firm like us, and you’re trying to help develop an emerging market product, we have difficulty getting good information, because disclosure in those countries, except for the large multinationals, is generally poor.”

“This is probably our number one strategic priority, figuring out how we can actively provide that information,” adds the London-based Guyatt. “There’s a perception, which does equate to reality, that ESG research providers do not have full coverage of emerging market companies.”

At the same time, the frameworks that research firms such as Jantzi-Sustainalytics use for developed markets simply aren’t appropriate for emerging market companies, says Mann.

“They deal with a different set of societal norms and so I think a lot of people are overstating our ability to understand what is a responsible organization in those markets and the ability of existing providers to supply useful information on those markets. If you’re going to do that research, you can’t just tweak existing templates for developed markets.”

Guyatt agrees. “The ownership structure of companies is so fundamentally different [that] it does require a new way of thinking and approaching the issues.”

Gaining ground Last year, Mercer and the International Finance Corporation, the private arm of the World Bank Group, conducted a wide-ranging study on sustainable investing in emerging markets. The global survey data, based on the practices of 10 global investment managers, concluded investment in sustainable investment-labelled emerging market funds was worth about US$50 billion in 2008. That’s a five-fold increase compared with 2003, but still only 1.55% of total emerging market investment.

Perhaps more interestingly, the study looked at sustainable investing in emerging markets themselves (India, China, Brazil and South Korea), which had grown to US$300 billion, as of 2008.

“While asset managers in developed markets are often credited with being a step ahead in factoring ESG issues into investment decisions, this latest research reveals that emerging market asset managers are beginning to take ESG issues seriously,” the study states.

That momentum is likely to continue, but don’t expect a mirror image of the responsible investing and ESG market in the developed world. “Cultural norms played a large role in how this market emerged and the cultural norms are quite different,” says Mann. “Funds that emerge out of those countries are going to be quite different but the funds that are driven from North America and Europe will probably fall in line with what we’ve seen in the past.”

Product picking From a practical perspective, the easiest way for responsible investors to get into emerging markets is to pick large-cap multinationals, says Mann. “We understand those companies and they provide more robust information because often they are listed on developed market exchanges. That’s much more consistent with the norms we use.”

However, small- and mid-cap companies are another story. “It’s problematic,” Mann states. “At this moment, we’d have difficulty suggesting a product that would satisfy most responsible investors.”

Still, the increased demand for exposure to emerging markets has led to the creation of a number of specialized sustainable investment funds, aimed at institutional investors.

“We’ve had quite a few requests from institutional clients about emerging markets investment,” says Christophe Vandewiele, head of Dexia Asset Management’s Canadian operations. Dexia has offered a sustainable investment emerging markets fund since 2008.

“To us, this makes sense, it’s logical,” Vandewiele says. “How can you invest in a public company where management doesn’t take into account things like climate change or corporate governance?”

Despite the increased allocation to emerging markets, there’s been no specific demand in Canada for Dexia’s relatively new fund, which has posted decent returns. Vandewiele believes it’s just a matter of time. “Maybe in five or ten years, sustainable investment will be the norm. People are asking questions, and that’s the first step. It’s moving in the right direction.”

Doug Watt is an Ottawa-based writer/editor specializing in responsible investment and is co-founder of SRI Monitor.

(05/04/10)

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