Investing for tomorrow: ESG in emerging market debt
For professional and institutional investors only
By L. Bryan Carter, Head of Emerging Market Fixed Income and Helena Vines-Fiestas, Head of Sustainability Research & Policy, BNP Paribas Asset Management
Investors increasingly consider environmental, social and governance (ESG) factors alongside traditional financial risks in investments. But many investors balk at the idea of using ESG criteria when investing in emerging markets (EM).
Just a decade ago, most countries facing fragile situations (whether political, social or economic) were low-income. The situation has improved with human development indices and other metrics demonstrating significant progress as many countries have graduated to middle income status. If we look ahead, some of the poorest countries with the lowest ESG scores may in fact produce the largest improvements.
Without question, many EM countries are departing from a lower base. Many of these countries arguably face the lowest hanging fruit in terms of gaining environmental efficiencies, safeguarding social goods and improving institutions of government. But these are precisely the countries that are most in need of long-term responsible investment to stimulate economic growth, job creation and strengthen their economic foundations.
These countries harbour the best set of ‘long-term improvers’, capable of generating outsized growth and asset gains for patient investors. Demographic trends and a growing middle class in many of them are generating rising demand for consumer goods, infrastructure, services and agribusiness, which provide new opportunities for investors.
Why mould this asset class into an ESG framework? We at BNP Paribas Asset Management do this not because we can demonstrate past returns from ESG factors, but rather we believe there is a moral imperative that drives our investment ethos to concentrate fiduciary assets in sustainable investments. This is driven by who we are as a firm, our role as first among peers in ethical investing, our long-term investment horizon, and our overarching risk mitigation philosophy.
It is our conviction that the future will not look like the past. There is no longer just a single EM group, with poor countries converging to industrialized status slowly and surely over time, and advanced EM countries graduating to developed countries.
The reality is different. Some countries are evolving in a positive direction in improving standards of living, policy frameworks and democracy; while others are regressing in terms of policy trajectories and quality-of-life factors.
Here, an ESG framework helps us separate the wheat from the chaff, applying a forward-looking focus on long-term success that is different from our daily, alpha-oriented investment process. Such an approach sends a clear signal to EM countries of investors’ focus on sustainability.
In short, there are two ways to generate alpha: either overweighting the champions or underweighting the pitfalls. EM investing is not just about finding the best markets; it is also about avoiding the worst ones. Long-term sustainability, in our belief, is synonymous with minimizing crisis or 'blow up' — which are, arguably, harder to predict. Further, we cannot rely on past cycles and back-testing, instead we need a view on what will matter going forward. At the same time, investors increasingly expect asset managers to have ESG lenses. Asset holders' ethos and views are increasingly shaping the industry. The desire for ESG-tailored investing is driving a more innovative and nuanced implementation of ESG research.
This article is second in a series on Sustainable Investing by BNP Paribas Asset Management. The next instalment will continue to explore how to integrate an ESG framework into emerging market debt investing.
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