In recent years emerging economies have been hit by market volatility, political disruption and the threat of rising interest rates in the US.
With so much to deal with, is it fair to expect emerging market companies to invest in ethical, social and corporate governance (ESG) matters on a par with developed markets?
Jeff Chowdhry, who manages the BMO Responsible Global Emerging Markets fund with Sam Mahtani, says the consequences of side-lining these issues can be fundamentally damaging to a business regardless of whether they are in a developed or developing market.
‘If businesses don’t adopt good ESG practices it can have a negative impact. Companies with poor environmental policies can get fined for regulatory breaches, or for spillages. If they don’t have good social practices, it can result in a high staff turnover, human rights issues and labour problems,’ Chowdhry says.
With potentially high returns on offer, emerging markets have often attracted investors willing to take more risk. However, Mike Sell, who manages the Alquity Future World fund with Roberto Lampl, says investors should always look at ESG factors as well as the dividend.
‘Long-term investors can sometimes be put off by an ESG label as there is a perception that by investing in this way you are giving up returns. That is absolutely false,’ he says.
‘All long-term investors should care about this because it gives you better returns. By having a responsible investment approach and focusing on these non-financial factors, you avoid issues which can eventually prove disastrous for shareholders. If you are going in to make a quick buck you don’t look at these things and ultimately you will come unstuck.’
Leaders and laggers
There are some emerging markets which score better than others on these metrics. Both managers cite India as having good corporate governance. Chowdhry favours private banks, while Sell says there is a history of NGOs which spread best practice. Both managers also agree on the emerging market with the worst ESG standards.
‘Of all the markets we look at in Asia, Korea is the worst for ESG by a mile. It is the most developed market and it has the worst corporate governance. Some of its largest companies have senior management indicted for bribery,’ Sell says.
Chowdhry picks up the baton: ‘Samsung Electronics continues to have corporate governance problems and issues about leadership. Even though it is one of the biggest emerging market companies in the world, its corporate governance is not up to scratch.’
Pushing for change
John Malloy, head of emerging markets at RWC and manager of the RWC Global Emerging Markets fund, says the situation is improving overall and external agencies are encouraging companies to reform. He cites China’s struggle to include its domestic A-shares in the MSCI index.
‘The MSCI is pushing Chinese regulators to reform and that is very positive. Right now a Chinese A-share company can suspend its stock from trading indefinitely and that is a big risk. How do you manage your portfolio if it is halted for months? In talking to MSCI in Hong Kong we know that they are asking Chinese regulators to come up with provisions which prevent that,’ he says.
Malloy says there have also been improvements at a company level in Brazil. Despite being hit by corruption scandals, oil producer Petrobras is looking to market leaders such as ExxonMobil to learn best practice.
‘They have no government appointees on their board now, there are no ties to the government at an executive level and the business is being run as a private company. Contrast that with Gazprom, where you have little corporate governance and no push for it.’
Elsewhere, Chowdhry has added Walmart’s Mexican subsidiary Walmex to his portfolio after the business improved its practices. ‘It was involved in a bribery scandal. At that point in time, we did not own it and only added it because of the changes it made to corporate governance,’ he says.
‘This is a good example of a company whose poor governance led to regulatory and operational problems, which then triggered a decline in share price. Parent company Walmart then began to impose its very good corporate governance practices onto the business.’
The penny drops
All this takes time and sometimes the motivation only comes once companies have actually understood the long-term benefits they stand to gain.
‘Once senior management understand it is not just Western investors imposing their values, but actually gives you access to a whole new set of investors who will then buy the share and help drive the price up, they get it,’ Sell says.
‘It takes time for the processes to be built in and for the reporting to come through. If you have never measured your carbon emissions, it takes you a while but then you can work out how to minimise them.’
Wherever in the world investors put their cash, Sell says ESG issues should be at the forefront of their minds. Even a company operating in a developed market can come unstuck when it comes to ESG, he says.
‘Look at the issues with Volkswagen, or some of the banks and retailers in the UK. It’s something that should always be analysed and is hugely relevant for any market whether it is an emerging one or not,’ he says.
This article originally appeared in the March edition of Citywire Selector magazine.