The Integration of ESG in Emerging Markets

Sustainability is a responsible approach to investing, as well as a business approach, that creates long-term shareholder value by capturing opportunities and managing risks that derive from the rapidly evolving global economy. Such changes include the shift of economic growth to the BRIC countries (Brazil, Russia, India and China), a fast-expanding global population, mass urbanisation and the industrialisation of the developing world. In our view, sustainable investing is the recognition that non-financial factors can materially affect a company’s long-term performance. A systematic incorporation of these ‘non-financial’ factors into a disciplined, fundamental investment process can lead to a more accurate assessment of long-term corporate value and ultimately enhance investment returns.

What do we mean by ‘non-financial’ factors? What follows is by no means a full list but simply some examples to give the reader more of an idea of some of the issues that are taken into consideration when assessing these non-financial factors. They include quality of management, corporate governance – practises such as transparency and disclosure, management accountability to shareholders, a company’s branding, image and reputation, new product developments, regulatory fines or litigation costs. Nor is the social side forgotten – how communities are supported or employees treated.

We believe that sustainability leaders achieve long-term shareholder value by positioning their strategies to capture opportunities from these changes while at the same time, successfully reducing and avoiding costs and risks.

Corporate sustainability is a business approach which recognises that companies are operating in an increasingly changing and challenging world. Globalisation and new political landscapes have combined with significant changes in populations, urbanisation, resource utilisation, climatic patterns, and employee and consumer attitudes. Corporate sustainability looks to create long-term value by managing the risks and capturing the opportunities that result from these trends.

Sustainable investment, meanwhile, is the recognition that focusing on long-term structural change will become increasingly important in generating superior long-term investment performance. Understanding how different environmental, social and governance (ESG) factors can affect a company’s performance is part of that analysis. There is a growing realisation that these non-financial factors can have a major impact on a company’s bottom line. In part, this is because these issues carry the potential for material risk, including social and environmental damage and legal liability.

And there is also evidence that when companies adhere to ESG principles, it can have a material positive impact on revenues. Corporate sustainability makes good business sense. If, for example, a company can save money by reducing waste, utilising raw materials more effectively and using less packaging, it is a win-win situation. It is good for the company’s profits and good for the planet.

Interpreting and incorporating ESG information into a disciplined, fundamental investment process can enhance investment returns over the long run.

Academic research has identified a positive correlation between companies with high sustainability standing and their financial performance. This is because managers who understand the long-term risks facing their companies and industries will formulate a deeper understanding of the implications for long-term finances and profitability. A long-term investment horizon is critical in order to integrate ESG factors into the investment process.

We believe ESG factors are relevant in all regions – both emerging and developed. But because of the growing demographic and resource challenges, a more sustainable approach to economic development is particularly crucial in emerging markets. Many developing economies face rapidly growing populations and these challenges force governments and companies alike to focus on a much more sustainable approach. A major problem is that in the past, rules and regulations have been either absent or lax and where legislation does exist, enforcement has been inadequate.

Add to that, a lack of available information. Poor visibility and the time-consuming process that it takes to extract that information make the investment side of sustainability challenging as well.

We regard disclosure as an important step along the road to good ESG management because a decent level of disclosure highlights a company’s risk management capability. Disclosure is particularly crucial for those emerging market companies that compete globally, as they are subject to assessment of their abilities to comply with evolving international standards.

Many globally-oriented emerging market companies are participating in the UN Global Compact. This is a framework for businesses committed to aligning their operations and strategies with ten universally-accepted principles in the areas of human rights, labour, the environment and anti-corruption.

As the world’s largest global corporate citizenship initiative, the Global Compact is first and foremost concerned with exhibiting and building the social legitimacy of business and markets. Many other local regulations are also evolving rapidly and with these will come stronger enforcement powers. One high-profile example is the plan by China to publish efficiency and conservation targets for all sectors.

A large amount of due diligence and patient research is required to extract the relevant ESG data on emerging market companies. As more investors engage with management on sustainability issues, an increasing number of emerging market companies prepare separate sustainability reports to accompany their annual reports. This is one of the areas where we have seen the biggest improvements over recent years. Good quality reporting leads to improvements in sustainable development because it allows organisations to measure, track and improve their performances on specific issues. There are many companies with high standards of sustainability disclosure – from large, internationally-recognised names such as Sasol of South Africa to small-cap names such as Petra Foods of Indonesia.

The standard of disclosure in Brazil has been improved by the creation of the Novo Mercado – a set of stock market listing requirements that demands improved corporate disclosure by companies. An increasing number of companies are choosing to list themselves on the Novo Mercado and admission to Novo Mercado requires compliance with corporate governance rules that are more rigid than those required by current Brazilian legislation.

When promoting ESG in emerging markets, lessons can be learnt from the west – both in terms of what to do and what to avoid. One pertinent example is the role that securitisation of debt played in the credit crunch. Many emerging economies have yet to experience the growth of mass-market housing loans. But they can learn vital lessons from the developed market experience – in particular, the need to ensure the gap between the origination of the mortgage and its ultimate ownership and supervision does not grow too wide. Areas such as this are likely to have ramifications for financial sector regulation in many emerging market economies.

Sustainability is a wide-ranging and varied topic to try to condense into a few pages. We believe that the most important thing to stress is the growing significance of the topic. SWIP first began managing sustainable portfolios in emerging markets almost five years ago. Meanwhile, we have more than 20 years’ experience managing socially responsible portfolios in developed markets. The identification of companies focusing on long-term structural change will become increasingly important in generating outperformance.

This article first appeared in The Future of ESG Integration: special report of Responsible Investor (Pg 15, November 2009). For more information, please visit