Marcin Adamczyk, NN Investment Partners’ head of emerging market debt, says that by actively engaging with emerging market countries, investors can influence how they tackle global ESG challenges.
Emerging markets provide an opportunity to positively impact the development of ESG factors, given that they are generally lagging developed markets on this aspect of investing. The road to development for emerging markets can be influenced by stressing the importance of sustainable development and setting the right incentives for them to achieve more sustainable outcomes.
Emerging market countries need external financing to continue on their path to development, and when investors expect them to do this in an ESG cognisant manner, both countries and investors can achieve their goals by focusing on ESG factors.
Excluding emerging market countries based on their current levels of sustainability can limit their ability to develop. Furthermore, it is the development trajectory that provides an interesting investment case for investors, as a country’s positive economic, political and ESG development will reduce the risk premium investors pay on the debt issued by this country.
It is also by investing in these countries that investors can take the opportunity to engage with their policymakers and corporates and help influence positive changes.
Emerging markets pose unique challenges, which have the potential to bring about positive changes.
First, countries in the earliest development stages tend to face a catch 22 – they need capital to fulfil their development goals, including an improvement in their ESG scores, but investors can be unwilling to fund them because their scores are currently low. To overcome this, investors can instead construct a framework that is specific to the situation in emerging markets and that examines a country’s direction of travel, not just where things stand today.
A second challenge is the shortage of relevant and accurate data. If data is available, it is often out-dated, backward-looking or plagued with missing values. Again, tackling this comes down to building the right frameworks. Investors need a framework that handles this data carefully and provides confidence in its explanatory power.
Next to the data treatment, it is important to have the experience and network to be able to assess the data from a qualitative point of view. We regard the input of specialised ESG analysts with a specific focus on emerging markets to add a lot of value. Prior to the Covid-19 pandemic, portfolio managers and analysts could travel to countries and talk directly with governments and central banks or engage with them at international conferences. These meetings continue to take place in an online format, but interactions remain frequent.
The final challenge is the diversity of the investable universe, which may create difficulty in finding a common denominator between a culturally diverse set of countries. The benefit of developing a proprietary model is twofold.
First, asset managers can ensure that the model fits well with their established investment process. Second, as ESG data continues to improve in terms of both frequency and availability of indicators, the model can adapt more quickly to these improvements.
The benefits of inclusion
When deciding whether to invest in an emerging market country, investors should bear in mind the benefits of inclusion – by excluding certain countries it may become harder to solve global problems, such as global warming, pandemics and inequality.
In actively engaging with all countries, there is an opportunity to influence positive change, by creating a platform to discuss issues with country representatives and show what is important for investors. After all, any country has the ability to grow and develop further and will have to, as this paves the way to tackle global challenges.
Engagement with sovereigns is usually more time-consuming and slower versus engagement with corporates. Sovereign states need to balance the stakes of their inhabitants, investors and their policy objectives. However, it would not be prudent to expect them to change policy overnight.
Formal investor groups have also come together to engage with governments. A good example of this is the engagement with the Brazilian Government regarding deforestation. We believe it is important that like-minded investors unite and send a strong message to these countries that certain issues need to be addressed.
Another argument for investors to join forces and interact with the respective governments of these countries is around the transparency of debt the country has issued. Often, investors are not the only lenders to the country which, for example, also has other multilateral and bi-lateral lending arrangements in place.
While having different financing options available increases the issuing country’s toolbox and provides multiple anchors, the transparency around the options used and their frameworks would allow investors to apply and maintain an inclusive lens.
Investors can play a role
The world is changing, and so are emerging markets, with huge strides in awareness taking place. Increasingly, emerging markets are issuing green and social bonds, which shows they are increasingly financing environmentally green and social projects.
There are challenges to be overcome, but by working to achieve their development goals, emerging market countries can retain access to capital, while interaction and transparency helps investors assess their progress.
Marcin Adamczyk is head of emerging market debt at NN Investment Partners
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