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Emerging markets warm to ESG outcomes

22 Jan 2018

Michael Bourke

At a recent Camradata roundtable discussion, Michael Bourke, fund manager on the emerging markets team, spoke about why he is encouraged by improving ESG standards within emerging markets.

Environmental, social and governance (ESG) considerations are increasingly at the top of the agenda in emerging market investing. There is a greater focus on extracting ESG-focused outcomes with many new mandates being wholly driven by ESG responses. As investment managers, we need to be prepared for this.

Two changes have struck me over the past year or so. The first is, somewhat ironically, China’s lead in global environmental initiatives especially in regard to COP (UN Climate Change) conferences since the US stepped down from the table. China is making great strides in steering its economy away from the traditional, high-pollution, manufacturing industries and towards consumer-led growth. This model would put sustainable, environmentally-friendly sectors such as healthcare, insurance and consumer technology at the forefront of growth. Although there are as yet no strict regulations governing how much information a company has to divulge about its ESG efforts, some Chinese companies are voluntarily disclosing their ESG data, a very positive step.

Second, corporate management is more responsive and sophisticated in responding to ESG questions and how the adoption of specific practices could lead to improved shareholder outcomes. For example, in Russia the perception of Russian political governance is very poor, but corporate governance in a number of instances is improving.

Management are not willing to talk about these issues, but are actively steering their companies towards better outcomes, particularly around governance. In the oil sector, one of our holdings, LukOil is not only focused on meeting global environmental initiatives and standards, but also on maximising returns from its capital allocation decisions. In governance terms LukOil is, in our opinion, one of the best in the emerging markets in its sector.

A value stock can be a value trap if you have poor governance practices and as such, governance has always been at the heart of our emerging market investment process. While there are some firms with excellent governance standards and a commitment to shareholder value creation, there are many companies in the emerging market universe that are not run in the interests of all their shareholders. For instance, there are numerous companies with dominant shareholders, such as the state, who dictate how the company operates, often to the detriment of minority investors.

Despite recent improvements, in China, for example, the majority of the stock market, from a market cap perspective, is made up of state-owned enterprises (SOEs) in which the government retains a majority stake and exercises effective control. The issue of state influence is important because SOEs can be run for social benefits, such as employment, or to control key industries, like banking and energy. It is not uncommon for governments to use state-owned banks as a policy tool to achieve their economic objectives. We find it harder to trust SOEs with our capital as they can prioritise the needs of the state over minority shareholders. Nonetheless, the direction of travel in China is encouraging.

Similarly, in South Korea, family-owned conglomerates, known as chaebol, dominate the market. These groups have been criticised for a lack of transparency and ignoring the rights of minority shareholders. We pay close attention to their capital allocation decisions and whether they respect the interests of minority investors. Encouragingly, there are signs chaebols are responding to calls for reform by adopting more shareholder-friendly measures and increasing their dividend payouts.

Overall, we believe there is a positive trend towards higher corporate governance standards across emerging markets. We are finding increasing numbers of well-run, shareholder-oriented companies, which in some instances have governance practices that are, in our opinion, as good as, if not better than, their developed market peers. As emerging market firms adopt global ambitions, management teams are becoming more professional and more international in their approach, benchmarking their businesses against global peers rather than just domestic rivals.

In terms of personnel, greater diversity and experience among senior management teams undoubtedly helps them to operate in a global marketplace. We are optimistic that governance standards will continue to improve as firms embrace good capital discipline and focus on their investors and that improving standards will be adopted more broadly across environmental and social issues as well.

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Wherever any indications of past performance is shown, please note that this is not a guide to future performance.

 

 

For Investment Professionals only. This article reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. Past performance is not a guide to future performance. The distribution of this guide does not constitute an offer or solicitation. It has been written for informational and educational purposes only and should not be considered as investment advice or as a recommendation of any particular security, strategy or investment product. Reference in this document to individual companies is included solely for the purpose of illustration and should not be construed as a recommendation to buy or sell the same. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents. The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of the Professional Client as defined in the Financial Conduct Authority’s Handbook. M&G Investments is a business name of M&G Investment Management Limited and is used by other companies within the Prudential Group. M&G Investment Management Limited is registered in England and Wales under number 936683 with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority.IM1114 11/17

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