RI DigiFest 2020: panel write-up: ESG integration in emerging markets shows strong financial correlation

Many regions are making “leaps” and “catching up.”

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There is a stronger, more positive, correlation between ESG integration and financial performance in emerging markets than developed markets, said Fabiana Fedeli, Global Head of Fundamental Equities, Robeco.

Speaking at the Responsible Investor Digital Festival: Summer 2020 (RI DigiFest) on a panel titled: “Narrowing the gap on ESG between emerging and developed markets,” Fedeli told delegates that emerging markets trail developed markets in ESG integration and awareness, but that many regions are making “leaps” and “catching up.” 

For example, new regulation around stewardship codes and reporting standards is appearing. Elsewhere, transparency is growing with an increased use of English language in corporate disclosure.

ESG is integrated by Robeco’s in-house teams using fundamental and sustainable analysis. The asset manager’s sustainability team identify the most material ESG issues on a company-by-company basis. Financial analysts then take those issues “back to the drawing board” to include them in their fundamental analysis, she said. A Chinese cement company, for example, may need to improve its environmental standards with consequences on capital spending and revenues that inform valuations, she explained. 

The material ESG issues that impact companies in emerging markets and developed markets vary. Companies in developed markets typically struggle to manage innovation and improve corporate governance while in emerging markets, corporate governance and managing environmental issues are the biggest challenges. For example, many companies in emerging markets must work hard to engage with local communities to ensure they can operate successfully, she said. 

Fedeli added that Robeco’s corporate engagements mirror those material issues. The firm engages with more companies in emerging markets than developed markets – 190 companies in emerging markets last year – and that the focus is governance, board independence and environmental issues. “Stewardship codes help strengthen our engagement ability,” she said. 

As for using its voting to influence corporate behaviour, the firm votes mostly on capital management and board composition in emerging markets. Much of its voting in emerging markets is in line with other shareholders. She also noted that emerging market companies are working on improving their data.

Juliana Hansveden, Portfolio Manager for Nordea Asset Management’s Emerging Stars Equity Fund told delegates how the firm does its own proprietary ESG research, and approaches ESG like any fundamental analysis or keen eye for mispricing. “The fact that data might not be perfect for us is an opportunity,” she said. The asset manager aims to beat the benchmark and uses ESG to help understand the context in which the company operates. When it finds material issues, the manager also engages with companies. “Because we are long term investors, we also have a long-term engagement process,” she says.

It’s an investment process that means the manager tends to invest more in “asset light” businesses compared to “asset heavy” business, she said.

Hansveden gave listeners an insight into Nordea’s engagement with South Korean conglomerate Samsung Electronics. ESG risk appeared via a corruption scandal and the manager was quick to begin engagement: “We travelled to see them,” she said. It began a process of improvements at the company, which included setting up an oversight committee separate to the board and more transparency around charitable donations. The manager has also engaged with the company regarding its relationship with unions. “Emerging market companies improve over time,” she said.

In the Samsung case, Nordea engaged on its own, yet Hansveden said the asset manager just as readily engages with peers: “It depends on the company and the opportunity,” she said, adding that Nordea only has one emerging market mining company in the portfolio – Chilean group Antofagasta. Here, engagement has centred around the group’s use of water. She said emerging market mining groups are “high risk” from an ESG perspective but added that “the right companies” do exist.

Fellow panellist, Amandeep Shihn, Head of Emerging Markets Equity and Sustainable Investment Manager Research at Willis Towers Watson said asset owners need to push managers on better ESG integration in emerging markets. But he also noted that demand for emerging market allocations has fallen. “Globally, demand for emerging market equity has been low over the last few years,” he said. Emerging market equities are risky and volatile, and typically make up a small portion of an overall equity allocation. Moreover, pension funds are reducing their risk allocations and dollar strength has contributed to lacklustre demand. 

The panel discussed the increasing importance of the SDGs as investors look to incorporate impact. At Robeco, the focus is on looking at what companies produce. Sometimes the manager works with companies to “get them over the line” for a stronger SDG impact score, said Fedeli. At Nordea, looking at impact via the SDGs is “very much part of the process.” The asset manager looks at SDG-aligned opportunities and notes that it is increasingly difficult for a company to have a sustainable growth strategy that “significantly detracts” from the SDGs in the long term. 

Shihn noted that the SDGs are just as relevant for investors in developed markets as developing markets: “When investors think about capital allocation, they need to think about what they are achieving,” he said. 

The panel also discussed the importance of engaging with companies in emerging markets rather than exclusion or deciding not to invest. Although some companies are “beyond engagement,” in the main, engagement reaps rich rewards both in corporate results and on the company’s wider impact. Panellists also noted that while governance risk tends to be higher in emerging markets, it is not always the case. 

For example, in South Africa reporting around human capital risk is better than in many developed markets, said Shihn. Moreover, other factors influence relationships and ESG integration in emerging markets like the fact many companies are SOEs with dual economic and political mandates, or family-owned where investors find themselves materially aligned with the ownership. The panel urged a nuanced approach across different regions, rather than putting all emerging economies in the same basket.