Making an impact in emerging markets

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Emerging markets can offer institutional investors the largest impact scores and help them fulfil their investors’ needs, but how can they manage the investment risk that comes with it?

The appeal of impact investing has grown considerably over the past decade, particularly as institutional investors have become more interested in having a positive social impact and generating a financial return.

One of the areas that has benefited from such interest is emerging markets, where there are greater opportunities for investors’ cash to have a bigger impact.

Home to around 85 per cent of the global population, emerging markets also face some of the biggest challenges regarding the attainment of the 17 UN Sustainable Development Goals. Achieving these by the UN’s target date of 2030 could cost up to $7tn (£5.1tn), highlighting the size of the opportunity.

As such, it is an area that investors are increasingly looking to add to, according to the Global Impact Investing Network’s 2020 Annual Impact Investor Survey.

More than half of respondents said they planned to increase their allocations to south-east Asia and Sub-Saharan Africa (52 per cent) over the next five years. Meanwhile, 44 per cent planned to increase exposure to south Asia, and 41 per cent will increase allocations to Latin America and the Caribbean in the coming years.

Plenty of opportunities

Erik Davey, director for UK and Europe at Secor Asset Management, says emerging markets can be a rewarding area for impact strategies as they are often commodity-intensive and high-growth economies.

“Both of these characteristics mean they will play an important role in how the world addresses climate change and many other responsible investing priorities,” he notes.

“Efficiently consuming commodities and transitioning to those that have a positive impact on the environment will be important elements of the transition to a low-carbon economy, and a great deal of this will need to be achieved in emerging economies.”

“As ‘impact’ as an asset class is still coming of age, the market is mostly focused on developed companies, which we see reflected in investor allocations and the number of products being launched”
Tom Baird, Redington

And many emerging market companies are well-aligned with impact themes, such as financial inclusion, health and the environment, says Tom Baird, senior vice-president of manager research at investment consultancy Redington.

“As ‘impact’ as an asset class is still coming of age, the market is mostly focused on developed companies, which we see reflected in investor allocations and the number of products being launched,” Baird explains.

“However, we would anticipate that emerging markets will be coming more into focus given the opportunity set available.”

Taking on greater risk

Nevertheless, there are heightened risks associated with emerging markets investing that institutional investors will be aware of.

Governance issues, less transparency and weaker legal regimes will be familiar to anybody having invested in the asset class, but this should be overcome by the greater possibility of getting more “bang for your impact buck”, says Baird.

Ingrid Kukuljan, head of impact and sustainable investing at the international business of Federated Hermes, says there are specific challenges when it comes to implementing a successful impact strategy in emerging markets.

“We want to ensure that our investee companies have impact and sustainable objectives defined as part of their strategy and there are clear key performance indicators”
Ingrid Kukuljan, Federated Hermes

“In order to manage impact efficiently, our approach in emerging markets is the same as in developed ones, in that investors need to do proper due diligence and engage with companies,” she says.

“To minimise risk, we want to ensure that our investee companies have impact and sustainable objectives defined as part of their strategy and there are clear key performance indicators.

“We also want the management to be aware of the impacts their business has both in terms of input — ie, supply chain and output. Lastly, investors should assess the impact of each investment, monitor the progress and engage appropriately.”

A key part of the investment process

Patricia Ribeiro, senior portfolio manager at American Century Investments, notes that while measurability of impact investing in emerging markets is difficult, it is not impossible. Instead, she explains that it just requires more time and effort to understand a business.

“In emerging markets, an important challenge is that many companies do not yet have sustainability reports — they are still learning about this space,” Ribeiro says.

“Often, we find that they have the information but have not thought of publishing it in a report, so engagement is very important.”

That is an opinion shared by Davey, who points out that engagement allows “to make improvements in the investment’s ESG characteristics rather than just exclude those that do not meet certain thresholds”.

“This focus on making a real and measurable difference is a significant differentiator relative to strategies that just focus on exclusion,” he says.

Ribeiro adds that engagement is “a natural part of that process”, since the manager already has “a dialogue with companies about their business fundamentals”.

Ribeiro concludes: “Even though emerging market corporations are not currently at the level of disclosure seen in developed markets, our experience suggests that corporate willingness to converse and engage on these issues is improving.”