Investing in tomorrow: ESG in emerging markets

Written By: David Crawford Co-Head of Institutional & Wholesale Distribution UK Nordea Asset Management

David Crawford of Nordea Asset Management outlines how investors can best identify opportunities in emerging markets that satisfy the ESG criteria set in the developed world

When the celebrity who breaks the record for the greatest number of new Instagram followers is not a Hollywood superstar, but the venerable naturalist, Sir David Attenborough, it’s obvious that environmental awareness isn’t just mainstream – it’s at the very top of global awareness.

Last year was “the year of ESG” according to the Financial Times, with assets in the “environmental, social and governance” (ESG) space reaching a record high of USD 960 billion by the end of the year¹. The coronavirus pandemic will most likely accelerate the drive towards investments with strong ESG principles, as the market shock set in motion by the virus underlines the huge material risk of failing to consider public health, governance, and environmental outcomes. Many investors have interpreted the coronavirus as a wake-up call to the potentially devastating effects that climate change could have on humanity and therefore markets. In addition, at the height of the coronavirus-induced market crisis, emerging market investments with strong ESG rankings showed resilience in the face of the severe drawdown and outperformed.²

Nobel-prize-winning economist Milton Friedman may once have argued that the only social responsibility of a company was to its shareholders, but that view no longer chimes with the times. In fact, in one survey³ an overwhelming 81% of investors said they already factor ESG into their investment decisions and another 16% said they plan to do so. The reason for this ESG consideration is in order to impact society positively (said 80%), reduce risk (58%), and to meet stakeholder needs (47%).

Finding strong ESG credentials in emerging markets
The challenge for investors who want to access the undoubted opportunities for growth in emerging markets is how to find investments that satisfy the high ESG criteria set in the developed world. Finding ESG-aligned investments in emerging markets is undoubtedly difficult. They are both in short supply and highly sought after. And the danger of making uninformed and high-risk investments in these markets is great. No investor wants to be involved with a company like retailer Boohoo, which was investigated after a scandal broke about working conditions at its factories. The company’s shares plummeted by GBP 1 billion amid claims of poor pay and working conditions. Major retailers and investors were quick to distance themselves. The possibilities for making the wrong investment decision abound from companies involved with unethical labour practices, ecological disasters, pollution, blood diamonds, and other ethics violations.

Robust ESG legislation has yet to be put in place in many developing countries, so often the only way to find out if a company has good enough ESG credentials to be a viable investment is for an asset manager to have an in-house team of experts able to conduct extensive analysis before investing. This responsible investment team can use its expertise alongside established frameworks, such as the UN’s Sustainable Development Goals, to thoroughly examine a company and make sure that it will meet the demands and expectations of developed investors.

Meeting ESG challenges head on
If this research process doesn’t unearth any “ready-made” investments, then the in-house experts may need to roll up their sleeves and engage, ahead of investment, with companies that demonstrate potential and work with them to examine areas where their ESG credentials can be improved and brought up to standard.

For example, Nordea recently engaged with Ping An, an e-health provider in China, to address challenges around data privacy and quality control after our team identified these as core risks to the company. Following our engagement with the company, data security protocols including encryption and deidentification were implemented, along with the monitoring of system vulnerabilities and reactive incident response. Throughout the Covid-19 pandemic, the company’s platform has been well-positioned for the rapid surge in demand for its services. Our responsible investments team believes the company now demonstrates strong risk-management practices across both data privacy and quality control.

ESG engagement is exciting and represents opportunities on multiple fronts. It allows companies in developing regions to improve their way of doing business to meet investor standards. This way they gain investment, and the ESG benefits are all positive. It’s a true win-win.

How to lower the risks of emerging market investment
A proactive responsible investment team will usually screen out companies with poor environmental records, or that don’t look after their workforce, or where management structures and oversight don’t meet high standards. I believe it’s important to have restrictions around weapons manufacturers, oil sands, and coal extractors. We must also be aware that in different cultures, with different legal frameworks, we can’t necessarily expect business practices to be in place that are identical to our own. In these cases, we must look for opportunities to actively engage and bring about beneficial change that is positive for companies and investors.

When evaluating companies, it pays to take a holistic approach: look for growth potential, competitive advantages, a strong return profile, and the material ESG risks and opportunities. Assess how you can get involved, if necessary, to strengthen the ESG credentials before or during investment. Also assess how sustainability trends can positively or negatively impact the company’s business model, its value chain, products and services. In short, what you really want to find out is – does this business have a great and sustainable future ahead?

The power to engage
At the heart of a successful responsible investment strategy is the ongoing drive to engage with the companies and the industries you’ve have chosen to invest in. This is the duty of active investors.

Take as an example the pharma industry in India – one of the fastest growing sections of the Indian economy, and also one of the dirtiest. For years, Nordea has been talking to individual companies and to the industry’s Pharmaceutical Supply Chain Initiative (PSCI) about environmental and health impacts. We’ve visited Hyderabad and seen the severe industrial pollution there. It’s taken time, but things are changing. In response to the findings and to our investor expectations, the PSCI developed an improvement plan that included mapping Indian suppliers and sharing industry expectations on pollution management, auditing, and training.

The value in values
There’s no doubt that more and more investors are prioritising ESG as they deploy capital. There is no desire to return to the era when investors closed their eyes to the impact a company’s action had on the planet and on the people and just thought of the profit. Besides, values are valuable. Good businesses do good things in good ways because this means they will have a bright, long-term future ahead of them.

It turns out that what is good for the planet and its inhabitants is actually also good for business. And every company can join in with this movement. There is scope for all businesses to improve and atone for the errors of their previous ways. Diamond miners are now nurturing herds of elephants in their very own nature reserves (De Beers), while soft-drink manufacturers focus on creating fully biodegradable bottles (Coca Cola). The desire to make business better for the planet is at the top of the investor agenda, and surely this is something Sir David Attenborough would applaud.

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches, subsidiaries and representative offices. This document is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. This document may not be reproduced or circulated without prior permission. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and/or representative offices.

1. Imogen Tew, ‘ESG to rally army of new investors’ (FTAdvisor, 21 February 2020)

2. Period under consideration: 01.01.2020 – 31.03.2020. The performance represented is gross of fees, composite and historical; past performance is not a reliable indicator of future results and investors may not recover the full amount invested. The value of your investment can go up and down, and you could lose some or all of your invested money. For illustrative purposes only.

3. ESG Survey: Institutional Asset Manager 13 July 2020.