Research by MOBILIST and Intellidex has highlighted a growing tension between ESG investment strategies and flows to emerging and frontier markets. While ESG is often assumed to support development-oriented investment, the research shows this is not always the case. Based on interviews with over 50 investment decision makers and consultants involved in asset allocations to emerging and frontier markets, the research provides solutions on how the tension can be reconciled.
The research draws out several further insights for emerging and frontier investment flows, including:
- How the relative performance of emerging and developed indices is affecting asset allocation decisions;
- How global monetary conditions and the prospect of higher inflation are affecting emerging markets flows;
- How emerging market domestic policies affect foreign portfolio investment appetite.
We discussed these findings at our virtual event “Driving ESG investments into emerging markets: Roadblocks and solutions” on Tuesday, 14 June, 14:00-15:30 BST. As well as a presentation of the findings of the report by Stuart Theobald, Chairman of Intellidex, the event featured a panel discussion discussing the challenges, opportunities, benefits and collaboration potential within listed products in emerging and frontier markets. The panel was moderated by Laurie Spengler – CEO of Courageous Capital Advisors and speakers included Sarah Norris, Investment Director at abrdn, and Gregory Smith, Emerging Markets Fund Manager at M&G
Unmet need is also unmet demand
There is an acute need for capital to flow into emerging and frontier markets. Conversations on the progress towards achieving the UN Sustainable Development Goals (SDGs) can be sobering – according to the UN, between $5-7 trillion is now required annually to meet the SDGs in emerging and frontier markets. While this may seem stark, such unmet need should equally be understood as unmet demand. For example, in 2020, 86% of the world’s population lived in an ‘emerging economy’ country and 58% of total GDP was found in ‘emerging economy’ countries. Despite this huge opporutnity, only 3.6% of global pension assets were invested in emerging economies in 2018. Whilst the scale of the SDG challenge is enormous, so too is the opportunity for investors willing to undertake the necessary due diligence.
Data gap: Problem and opportunity
As outlined in the report, one of the most pervasive barriers to increased investment in emerging and frontier markets is the lack of regular, detailed data, especially around ESG. While this can act as a blocker for some, it can also be a competitive advantage and source of outperformance for specialists, who, through building strong analysis capabilities and close contacts in these regions, can access opportunities others ignore or discard. Investors must also recognise the tensions between the “E” and “S” of ESG. While environmental data has been developed much faster, and therefore tends to be dominant in emerging markets, much of the unmet demand centres around the “S” which can be more difficult to measure. Despite this pronounced data gap on the “S”, an impact approach should not neglect social investments as this is where significant positive impact can be achieved.
Blanket screening can exclude a vibrant investment universe
Screening at a macro- or country-level can lead to a significant bias against emerging and frontier markets, leaving capital back in developed markets and exacerbating the existing funding gap. Such screening can also lead investors to miss out on significant opportunities through both a financial and impact lens. Understanding risk more holistically can lead investors to investments that are actively solving pressing issues while generating a financial return.
Context and momentum are key
Investments in emerging and frontier markets must always be assessed within their specific local context, particularly when viewed from an ESG lens. Investors should be aware of the risks of applying ESG frameworks that assume a uniformity of governance and systems between different markets. Instead, investors should take a more nuanced approach, including consideration of forward progress towards the SDGs or other sustainability metrics. Such an outlook, coupled with an approach based on engagement with the investee, can unearth those companies and investments delivering significant impact within their country and solutions to unmet needs. This can also be applied on a country-level, with investors factoring in historic contributions to climate emissions to avoid bias against markets that are making progress toward a Just Transition.