Responsible Investor

Rising to the ESG challenge of emerging markets

Are long-term investors fully aware of the growing importance of ESG issues in emerging markets investments?

On 23 July 2007, Chinese officials announced that the release of a ‘green GDP’ report calculating the cost of pollution and ecological degradation had been “indefinitely postponed”, following strong lobbying by provincial governments and business associations. A previous report for 2004 had calculated that environmental degradation cost 510 billion yuan (US$68bn) or 3.1% of gross domestic product. The State Environmental Protection Administration commented that the total figure could be much higher, in the range of 10–13% of GDP. These figures do not include long-term impacts of global warming, to which China has become the world’s biggest contributor after surpassing the US, according to a recent announcement by the Netherlands Environmental Assessment Agency (see link).
Should institutional investors care? After all, emerging markets investments typically account for only a small portion of their portfolios.

We believe they should, for a number of reasons. First, regional and global economic effects from issues of the magnitude described above are unavoidable. Second, investors’ exposure to emerging markets is much larger than is implied by their notional allocations, given the increasing operational exposure of developed world multinationals to emerging markets. Third, such developments are likely to create market inefficiencies from which clever investors can profit.
Although environmental issues in emerging markets are increasingly catching the attention of investors, many material issues in the social and governance domains continue to go unnoticed. The effects of poor governance and corruption on long-term growth, for example, are not fully factored in by many investors. Academic research has indicated that more corruption is related to lower average income, higher poverty levels and lower trend growth rates.

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