Virus Spurs Emerging Market Investors to Seek Returns in ESG

(Bloomberg) — Emerging-market investors may have identified the rare animal that offers a path to sustainable post-pandemic returns. Now they just need to find it.

The worst crisis since World War II is prompting some fund managers to rethink their strategies in a world with $13 trillion of sub-zero yielding debt and an increasing view that a V-shaped recovery is unlikely. Seeking opportunities in ESG, investments in countries and companies that are improving environmental, social and governance standards, are becoming crucial more than ever as investors navigate the pandemic-stoked market volatility.

“This is a crisis unlike anything we’ve seen and we cannot just go back to our old textbooks anymore that say ‘go buy the dip’,” said Thu Ha Chow, a money manager at Loomis Sayles Investment Asia Pte, who has been investing since Enron’s collapse. “The social and governance elements are going to be more important, but they can be harder to find in emerging markets.”

The conundrum lies in the scarcity of such true assets and the difficulty of identifying them in developing economies.

While ESG-focused developing stocks and bonds have trounced returns of traditional peers as the pandemic raged, they’re a minority across the $28 trillion emerging-market universe. Just $11 billion of the $84 billion raised in bonds this year whose proceeds are applied to projects aimed at helping society came from developing-nation borrowers.

The coronavirus has splintered the world economy, exposing social responsibility and governance fault lines across continents. The fallout has been worse in less developed nations, which typically dedicate about 5% to 6% of GDP to health spending. That’s less than half the 14% average of wealthier countries.

As Brazil and India overtake the likes of Italy and Spain as pandemic centers, funds are scrutinizing the shelf life of their investments as emerging markets face their first annual contraction in six decades.

“We cannot just go back to our old textbooks anymore that say ‘go buy the dip’” — Thu Ha Chow, Loomis Sayles

The pandemic has “put focus on the critical need to build resilience in healthcare, food and water security, and across supply chains,” Ingrid Kukuljan, head of international impact investing at Federated Hermes in London, wrote in a note. “We will increasingly see governments transfer funds to the private sector to address these pressing needs, which has proven true during this crisis.”

While such bets have paid off — a gauge of ESG stocks has gained 3.8% in the past year compared with a 1.1% rise in a broader EM index — the lack of good research into such assets is hampering the market, money managers say.

Read more: Money Managers Battle to Make ESG Fit With Emerging Markets

Companies and governments in many emerging markets are not legally obliged to disclose as much ESG information as they are in developed nations. This has led to worries that lower standards, or greenwashing by companies that don’t have measurable rules could prove disastrous for investors.

Vale SA’s dam collapse in south-eastern Brazil a year ago unleashed 9.7 million cubic meters of mining sludge that buried part of a town and killed 270 people. The catastrophe wiped out a quarter of the miner’s market value at one point, and has scarred the company’s reputation.

“You need to have your own proprietary fundamental research,” said Claire Peck, an investment specialist in London at JPMorgan Asset Management, with $1.9 trillion in assets. “You have to be more research intensive as an investor because of that lack of transparency and also lack of coverage by major ESG providers.”

That analysis has to include not only the social aspects of the investment, but the long-term viability of the financial model.

Read More: Women-Led Activist Firm Bets on ESG Reforms in Emerging Markets

“There are a lot of solar tech companies for example, but if you look at some of them historically, they have been either frauds or haven’t met their cost of capital,” said Peck. “A business that doesn’t consider the environment is not sustainable, nor is a solar company that cannot meet its cost of capital.”

But doing the research independently adds to the expense, especially as ESG standards stipulated by index providers are constantly changing.

S&P Dow Jones Indices LLC is reviewing its sustainability benchmarks to include factors such as flexible work arrangements and a firm’s governance structures for handling sudden risks from medical issues. MSCI Inc. expects its ESG offerings to eventually gain more of a following than traditional benchmarks.

While ESG may be a good long-term bet, the volatility in today’s markets means investors have to be cautious.

“We are looking at some of these longer term trends but also realizing that in the near term, markets are more likely going to be driven by a tweet or the latest development with Covid,” said Karan Talwar, investment specialist in Hong Kong at BNP Paribas Asset Management. “Our focus has always been to focus on idiosyncrasies and not paint EM with a broad brush.”

Technology Bridge

One solution to long-term investment gains may lie in stocks and debt of technology assets that are linked to ESG, funds say.

About one billion people in emerging markets already use mobile technology for health care services, according to Loomis Sales. By 2025, 75% of people in such markets may have access to smartphones, fueling a jump not just in ESG, but in industries from education to logistics.

That’s a trend that already existed. Technology and finance stocks tend to make up the biggest weightings in benchmarks such as the MSCI ACWI ESG Leaders Index, accounting for more than a third of the gauge.

“Some of the trends that were happening anyway in markets and in portfolios were strengthened by Covid,” said Andrew Gillan, a money manager at Janus Henderson Group PLC, whose Asia Pacific equity fund has beaten 95% of peers in the last five years. “The winners continue to win in IT, e-commerce.”

Chinese tech behemoth Alibaba Group Holding Ltd. is one company that is channeling more efforts into ESG, while at the same time benefiting from a move to online economies.

“We clearly can see that the way we do business is changing and becoming more digital,” said Adrian Zuercher, co-head of global asset allocation at UBS Wealth Management in Hong Kong. “EM markets which have relied more on natural resources and traditional manufacturing business will face a more uncertain future.”

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