ESG investing can be harder to carry out in emerging markets but the benefits for bond-holders are still real, a report argues.
Investors in emerging market debt are slower to adopt environmental, social and governance approaches – such as avoiding fossil fuels - because they mistakenly fear that standards of behaviour are much weaker anyway and that data is hard to find, a study has found.
Insight Investment, part of BNY Mellon, has written a report which it says debunks “myths” about ESG investing as applied to emerging market bonds. With ESG approaches being touted by wealth managers, particularly as a way to attract younger investors, the paper argues the approach delivers value, spreads risk and does not sacrifice potential returns.
The report said there are two main reasons why investors are wary of the benefits from ESG approaches: Firstly, they assume companies in these regions are not run as professionally and honestly as in developed countries, making ESG approaches irrelevant; secondly, they worry there is a dearth of reliable statistics and information to make this investment model work.
However, Insight Investment argued that when similar-sized companies in similar industries in developed and emerging countries are compared, ESG ratings are closer than sceptical investors might think. The report compares the percentage of corporate debt issuers with Insight’s lowest ESG rating of five, across a number of sectors. (One is the highest possible score.)
“For the financial, TMT and oil and gas sectors, emerging market corporate issuers compare very favorably to US corporates. For two sectors, the percentage of emerging market corporate issuers scoring a 5 is marginally lower than for US investment grade issuers, and substantially lower than for US high yield issuers,” the report continued.
“Clearly the perception that ESG standards in emerging markets are always dramatically lower than developed markets is a misguided one. For utilities, emerging market corporates do score considerably worse than US investment grade equivalents in particular and this can be largely attributed to the former’s reliance on fossil fuels,” it said.
The rise of ESG investing has become a regular talking point in the wealth management industry. There remains debate on whether these approaches surrender returns because of ethical/financial tradeoffs or whether ESG approaches are just smarter investing in the long run anyway. A recent survey of US asset managers by Cerulli Associates, the analytics firm, showed a rising percentage of asset managers look at environmental, social and governance factors alongside more traditional financial tests to identify opportunities and risks. And another report by Boston Consulting Group and MITSloan Management Review found that investments that deliver financial results are closely correlated with those that are deemed sustainable (Investing For A Sustainable Future, 11 May 2016). Separately, a study by Barclays found that investment-grade bonds with higher ESG scores outperformed those with low ESG scores between 2007 and 2015 (source: MSCI).
There remain causes for concern. A 2016 report by EY for example, has flagged the challenge of “stranded assets”, such as oil and gas production facilities that become side-lined because of rising hostility to fossil fuels and divestment from carbon dioxide-producing sectors. (That report mentioned that in 2014, there was the Montreal Carbon Pledge signed by 92 institutions managing $6 trillion in assets, and the Global Investor Statement on Climate Change signed by 347 institutions managing $24 trillion.)