Emerging-market investments through an ESG lens

December 01, 2017 09:12
Strong corporate governance and sustainability practices are prerequisites for emerging-market companies in Asia hoping to compete globally. Photo: Boston Common

This year marks the 20th anniversary of the Asian financial crisis, which saw stock markets in all four Asian Tigers nosedive. It was also a time when investors were taking the first early steps to integrate ESG (environmental, social and governance) factors into investment decisions.

Two decades on, emerging-market economies including the four Asian tigers have become a major driver of the global economy, while interest in ESG has boomed – with over US$70 trillion of assets signed up to the UN-supported Principles for Responsible Investment.

These two developments are important because it is by looking at emerging Asian economies through an ESG lens – i.e. analysing corporate governance and environmental and social management practices - that can help investors both avoid downside risks and unlock valuable growth opportunities.

Investing in solutions

The first way that ESG analysis unlocks emerging market growth is by helping identify those companies providing the solutions to sustainability challenges. For example by looking at the challenge of how to provide drinking water and clean energy to the expanding middle classes in Asia and beyond, we can see companies well-placed to form the industries of the future.

One example is Beijing Enterprise Water Group which is capitalizing on China's widespread water pollution issues by providing sustainable waste-water treatment. In the first half of 2017, a company joint venture won 46 billion yuan worth of water environmental renovation projects.

BYD in China is another example, which nine years ago was a little-known mobile phone battery maker in Shenzhen but has now built on its battery expertise to become one of the largest Electric Vehicle manufacturers globally.

Meanwhile ENN Energy, China’s third largest natural gas distributor and a leading innovator, is well-placed to benefit as the country shifts away from coal – gas consumption has been growing at double-digit rates for the past five years.

ESG as a proxy for good management

But the ESG lens is not just about helping spot growing markets and products. It also provides crucial insights into the company’s management quality, operational efficiency and potential risk exposure – particularly important in more volatile emerging markets, often characterized by weaker regulatory structures.

For example, strong human capital management tends to lead to lower operational costs and higher return on capital. Bank Rakyat, an Indonesian bank with a strong micro-finance model, lends to the same community where it raises deposits, provides mentoring to women and small businesses in the community, and has an impressive recruiting and talent training program. As a result, the bank boasts an average return on capital of 25 percent, one of the highest globally.

Strong corporate governance also tends to go hand in hand with better financial performance. Management who pay attention to ESG issues also tends to be forward and long-term thinking. Indeed, a recent paper from Cambridge Associates notes that stock-specific ESG measures adds alpha in emerging-market equity investing.

Identifying the winners

Strong corporate governance and sustainability practices as well as a diverse leadership are all prerequisites for emerging-market companies in Asia hoping to compete globally and appeal to their growing middle classes at home. For investors, applying an ESG lens to both products and processes of these companies can help identify those best placed to compete in an increasingly crowded field.

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Emerging Markets Portfolio Manager at Boston Common Asset Management