Over the past decade or so, environmental, social and governance – or ESG – has evolved from being a niche theme to a mainstream investment approach. While this has been centred in developed markets, it is now becoming increasingly important in the emerging world too.
This makes sense. After all, developing countries are, in general, far more at risk from the effects of climate change, so environmental concerns should be something of a priority for companies in those areas. Meanwhile, as these companies become more global in nature, they find they have to comply with international standards.
Investing in emerging markets is also a way for investors looking to make an impact through their allocations to get more bang for their buck. If there is more room for improvement in these companies, and their growth ambitions require scrutiny, then institutional investors in particular can become a real force for good.
The way in which ESG factors are defined remains a challenge even in the developed world, and it certainly isn’t the case that companies in emerging economies can yet be held to the same standards as ones in Europe or the US. If they were to do that, they would see their universe of potential investments shrink dramatically.
For Roger Merz, head of the mtx boutique at Vontobel and manager of the Sustainable Emerging Markets Leaders and Sustainable Global Leaders funds, the approach to take is one which “looks to avoid the worst offenders”.
While some studies suggest better ESG scores lead to better share price performance, Mr Merz is not totally convinced by that argument and says more research is needed.
“But by avoiding the worst, you should avoid underperformance. And better ESG should mean lower volatility, which should mean better returns.”
Speak to anyone investing in emerging markets and they warn you that while the fundamentals may be solid, and the growth potential there for all to see, the volatility inherent in these regions is hard for some to stomach.
It may be that applying an ESG screen before investing in companies is a way of filtering out some of the more volatile stocks, or at least smoothing out some of the turbulence. In talking to fund managers for my recent piece on emerging markets for PWM, one theme that stood out was their search for “quality” companies. Find those, they argued, and emerging markets suddenly become a much less frightening place. And an ESG filter is one more tool which investors can use to help them do that.
Elliot Smither is chief sub editor and senior writer at Professional Wealth Management. Follow him on Twitter @ElliotSmither
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