Magazine Issues » September 2015

FRONTIER MARKETS: The next frontier for the ESG ideal

MeadowWith investor interest in both frontier markets and environmental, social and governance issues on the rise, Alix Robertson asks if these two approaches to investing can be combined.

Frontier market investing has risen in popularity in the past two years and might be thought to be at odds with environmental, social and governance (ESG) principals, particularly on issues like child labour and women’s rights.

In the investment community, discussions are taking place about how the diversification and return aspects of both investment themes might be combined.

Miguel Santisteve, associate director in the advisory services division at Nasdaq, is an expert on how investors integrate companies’ ESG indicators into their investment decisions. He says that the views of emerging and frontier markets should be included in ESG criteria.

While many investors are pushing companies to address environmental issues, such as climate change and reducing carbon emissions, other topics that impact heavily on emerging and frontier markets, such as human trafficking, need to come to the fore. 

“I think it is important that we remind investors that topics outside those issues that are grabbing the news headlines really deserve more time from them,” says Santisteve. 

Tundra Fonder, a Swedish asset manager that specialises in frontier markets, has recently taken steps to incorporate sustainable investing and ESG issues. In August, the firm launched the Tundra Sustainable Frontier Fund, based on the firm’s existing Frontier Opportunities Fund but with an ESG filter. The original Frontier Opportunities Fund launched in 2013 and has returned 56.4% since inception, compared to 32.5% from its benchmark, the MSCI Frontier Markets ex GCC Net SEK.

Mattias Martinsson, chief investment officer and partner at Tundra Fonder, explains: “Every time we had a discussion with an institution, the usual ESG questions came up. How would you know that there is no child labour involved in the companies that you invest in? What about employment rights? What about environmental issues and corruption?”

In response to this demand, the firm formulated an ESG policy with potential investors and hired two analysts to work on the issues locally. The sustainable fund has now been seeded with just over $12 million (€10.6 million) and the backing of three Swedish municipalities.

Martinsson has witnessed ESG developing rapidly worldwide and says for sophisticated investors looking at entering the frontier space, it is natural to request the same standards as they do in other markets. However, he adds that it is also important to be “humble”, because ESG matters have barely been addressed in some frontier markets.

The firm has screened the fund’s initial portfolio, raising potential ESG issues. It is now working to help the companies address them and setting a 12-month period in which changes are expected to be started.

Martinsson says it is also important to understand how different ESG issues manifest across the regions. 

“I expect us to have more issues in Vietnam ... when you have employees in factories, that is normally an area of special concern.

“In Nigeria, for example, we only work with companies in the financial sector; there’s normally fewer employment rights issues there. Instead, it’s possibly corruption issues.”

He hopes that the ESG approach will act as a “quality stamp” for the companies in Tundra’s funds.

“The more we communicate with other companies, hopefully they will see that there is a point to being open and transparent and that you will eventually get rewarded for abiding with standards that are being set by international investors.”

Some investors still have a way to go in seeing the potential for new frontier market investments. At Ashburton Investments, the investment management business of African financial services firm FirstRand Group, African equities specialist Paul Clark says that Africa in particular is misunderstood. 

Like Martinsson, he urges investors to consider the significant variations between the 54 different countries in the region, adding that some investors’ expectations of very high risk and very high reward are unrealistic.

“The continent is so diverse and there are a lot of smaller countries where you will typically have less governance, like Burundi, at the moment. But at the same time, on a relative scale you had a really good election in Nigeria, and Nigeria is the biggest economy on the continent, while Burundi is one of the smallest.”

He notes that 2015 is expected to be the single biggest year ever of foreign direct investment (FDI) into Africa. “The fact that you are seeing more FDI now than aid flows – that just shows you that things are really happening,” he says.

At Investec Asset Management, Therese Niklasson, global head of ESG, says the firm has seen an increasing focus on ESG issues from companies of varying sizes in African markets. 

However, she adds that public disclosure of ESG performance remains weak in many markets.

“Challenges for investors include appropriate and timely ESG data and reporting,” she says. “The reason for this shortage of data ranges from lack of awareness that investors are seeking the information, to it simply not being collected. We believe there is opportunity to change this through investor engagement.”

Alquity Investment Management is one firm that is engaged by the opportunities in markets such as Africa. Founded in 2010, it focuses on investing in emerging and frontier markets, while also promoting the use of responsible investment practices. 

The firm offers a general Future World Fund and four regional funds dedicated to Africa, Latin America, the Indian subcontinent and Asia respectively, with each subject to an ESG process. Alquity believes that ESG is beneficial ethically and in terms of profitability and risk management. 

Its ESG process involves some negative screening to avoid products such as tobacco and hard spirits, and a focus on deep engagement with companies, paying close attention to themes such as the emerging consumer.

Paul Robinson, chief executive officer of Alquity, also highlights the challenge of a lack of data in emerging and frontier markets, but believes that a focus on ESG can help to provide an “information advantage”.

“There’s less published data, so the more you can understand about these businesses, the better. It’s a source of alpha, and we believe that gives us some of our outperformance against competitors and reduces our volatility.  All of our funds consistently have less volatility than the peer group.”

The firm regularly visits the regions it invests in to gather information and engage with companies and their local communities. Robinson says understanding how the businesses engage with the rest of the society is very important in allaying investors’ fears about political risk, corruption or insufficient oversight.

A long-term approach is another factor he believes is important. “Our turnover ratios are very low... at about 20%,” he says. “ESG is often about recognising long-term returns and doing things the right way, rather than short-term exploitative approaches.”

He gives the example of Lonmin, a platinum mining company in South Africa. Platinum is used as catalyst in converters, offering benefits from the perspective of lowering greenhouse gases. 

“We looked at Lonmin, and there was just no way that we could get remotely comfortable with their labour relations and their health-and-safety practices.

“We’ve not gone near it. Then, 18 months after looking at it, there was the Marikana mining disaster.” 

The incident saw 44 people killed by police at a mine owned by Lonmin in the Marikana area, near Rustenberg in the North West Province. Of these, 41 were striking miners.

The event, which made headlines across the globe, was “a human tragedy and also a financial disaster, with stocks down 60% against the Johannesburg Stock Exchange (JSE). Before that, it pretty much tracked the JSE,” Robinson says.

Another aspect of the firm’s strategy is to donate between 15% and 25% of fee revenue to help the regions it invests in to move forward.

“You could argue this is a good end in itself, but at the same time if you elevate [people] from sitting on the side of the road to actually having a job and creating income, then they become the consumers that buy the products from the large-cap companies that we invest in; so you get this virtuous circle.”

He concludes that a more open approach to ESG in frontier and emerging markets would be beneficial for both investors and the regions they invest in.

“This is an industry that doesn’t find it easy to think about things that are perceived as softer. I think there’s a great opportunity here to help people understand that you should have an option for your clients that says yes, I want to invest responsibly.” 

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