With global growth accelerating, emerging market (EM) corporate fundamentals continue to improve. Moreover, EM corporate bonds offer attractive valuations in the current low-yield environment. But for investors sensitive to responsible investing, this asset class is often disregarded.
Indeed, when one mentions the idea of including environmental, social and governance (ESG) criteria or positive impact selection in constructing emerging market (EM) corporate bond portfolios, the first reaction is often one of scepticism. Admittedly, ESG norms and requirements can be looser in some EM countries, and news headlines have pointed at cases of poor practices, involving for instance child labor, water pollution or corruption. But, as we know, bad news travels faster than good news.
Most would have heard of the Car Wash (Lava Jato) corruption scandal in Brazil. But who has read about the CEO of Turkcell Illetisim Hizmetleri, who was recognised by the United Nations as one of the ten 2017 SDG (Sustainable Development Goals) Pioneers? Kaan Terzioglu was distinguished for creating the “Hello Hope” mobile app, which aimed to help refugees access key health and education services. In Mexico, IEnova, a company which develops, builds and operates energy infrastructure, demonstrates strong sustainability policies, including best practices in terms of health and safety standards and developing projects to preserve biodiversity, such as reforestation and wildlife protection. MSCI ESG Research LLC recognised such best practices by assigning it a single-A ESG rating.
So, even if such companies are not that well-known, there are EM champions who distinguish themselves for their above-standard ESG credentials or for the positive impact they can contribute to society, in line with the UN 17 Sustainable Development Goals.
The responsible investing trend has also caught the attention of policy makers. Environmental considerations are by essence global, and emerging countries are aware of this. Among the 79i EM countries included in JP Morgan EM sovereign and corporate bond indices, all are signatories of the Paris Agreement on Climate Change and only twelve have not ratified it yet.
Stricter environmental requirements are thus likely to impact developed market (DM) and EM corporate issuers alike. For instance, China’s commitment to reduce pollution has already resulted in stricter norms.
Companies have to adapt or face the risks of high litigation costs and fines. Not all will be able to do so, which is expected to lead to further concentration in industries like steel, paper or textile. Over time, this will likely impact companies’ operating performances, credit metrics, and financing costs, and will eventually be reflected in the performances of portfolios invested in the fixed-income or equity securities issued by these companies.
ESG analysis is thus not only useful to single out the “good” companies. It can also be a means to identify potential sources of risks that could cause sharp underperformance. In the case of Samarco, a Brazilian mining company, recognising the weak history of both its parent companies in terms of pollution could have served as a signal of future risks, which eventually materialised when the Bento Rodrigues dam collapsed in November 2015. This disaster released about 60 million cubic meters of iron ore waste,
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