Values – Rather than Value – Investing Proving to Be an Edge in Emerging Markets

When the word “value” is used in conjunction with investing, most think, quite naturally, of the process associated with selecting stocks that are priced lower than their intrinsic worth. There is, however, another kind of value investing – or, more accurately, values investing – that has been around for some time, but which has encountered difficulty gaining much traction, and therefore, much by way of investor interest…until recently.

Investing on the basis of values has been more prominently known over the years as either socially responsible or morally responsible investing, depending on the precise nature of the philosophical goals one seeks to realize (along with their more pecuniary objectives). Although the terms have been used interchangeably by many, and each is free to interpret what constitutes socially responsible and/or morally responsible to them, there are generally-accepted definitions of each. Socially responsible investing tends to refer to the management of a portfolio in such a way that securities are screened on the basis of a company’s adherence to evolved practices in realms like environmental protection, human rights, diversity, and other, similar areas that many would consider more representative of a progressive orientation. Morally responsible investing’s concern is principally that of ensuring those companies that produce goods broadly seen as “immoral,” such as alcohol, gambling, and pornography…remain excluded from portfolio consideration.

These ultra-brief descriptions of that which characterizes socially responsible and morally responsible investing are hardly complete, but you get the picture. Additionally, it should be noted that, depending on one’s personal philosophical outlook, components of each will frequently overlap. For example, Christian-based morally responsible investors may not have an acute problem with fossil fuel companies, and more agnostic socially responsible investors may have no issue with those businesses that make alcoholic beverages, but both might object to companies that manufacture weapons.

One of the principal difficulties with investing in either/both fashions is that, historically, the track records associated with doing so have not been terribly good. Intuitively, it is not difficult to understand why that has been the case. Investors gain greatest benefit when they avail themselves of the opportunity to evaluate their prospective holdings purely on the basis of fundamental and/or technical factors, without regard to any other considerations, and, least of all, those that pertain to personal ideology (unless, of course, one’s personal ideology is centered on little more than making a buck).

That said, the increasingly progressive bent of the world is such that it appears such investing is here to stay. What’s more, its persistence in remaining a part of the asset management landscape has seen it morph into a more mature version of what it once was, both in name as well as in concept. Socially/morally responsible investing is now formally known by investment professionals and individual investors alike as environmental, social and governance (ESG) investing, and it has gained real gravitas within the professional investment community, particularly in light of its markedly-improved performance within select markets.

More specifically, in the realm of emerging markets, ESG investing is proving to the better of its non-ESG counterpart, in terms of return: For calendar year 2017, while the MSCI Emerging Markets Index returned 11.60 percent, its ESG counterpart, the MSCI Emerging Markets ESG Index enjoyed a total return performance of 13.83 percent for the year for a nearly-20 percent better return.

By contrast, and notably, the performance of ESG investing in the United States for the same period, in comparison to a counterpart non-ESG portfolio, was hardly as stellar. To wit, the MSCI USA ESG Index returned 13.83 to investors in 2017, while the MSCI USA Index returned 14.08 percent.

Could it be, then, that the reason socially responsible/ESG investing has been historically underwhelming is that investors have traditionally looked no further than at those companies available in their backyards, when the real benefit at investing this way is found by going to more remote, less developed regions of the globe? Just what is the deal with the emerging markets, and why is ESG investing proving to be such a good bet there?

One of the long-standing knocks on ESG investing is that while many interested parties apply their screens in a way to weed out objectionable companies, that is, obviously, not the same thing as seeking out ESG-friendly companies in an explicit attempt to improve alpha. As it happens, an eye-catching difference between ESG investing in emerging markets and in developed markets appears to be the opportunity to use the paradigm for the achievement of alpha. Shreenivas Kunte, CFA, speaks to this issue in his piece “ESG in Emerging Markets and Beyond: Where Is the Alpha?”

Making the case for portfolio avoidance of non-ESG-friendly companies, Kunte points out that “almost every couple of years, companies with shallow ESG records end up as case studies in value destruction.”

Still, he continues, the benefits of specifically targeting companies with quality ESG measurables for the purpose of realizing alpha remain woefully underemphasized:

“There are companies whose promoters have no intention to tighten ESG standards, while others have stakeholders who are willing to improve but lack the knowledge or the foresight to do so. Investors could work with these promoters on their ESG records, or look for changes in companies that are moving up the ESG performance curve. This can result in significant alpha to investors as they benefit from a valuation multiple expansion, better capital allocation, and improved cash-flow quality. It is similar to junk or high-yield investing — generating returns from high yield and price appreciation.”

In fact, writes Kunte, “ignoring ESG norms to build a business could create permanent walls against growth and capital formation,” and that those who invest in developed countries wouldn’t likely even consider those companies that have checkered or otherwise less-than-premium ESG records. It is precisely for this reason that, as Kunte goes on to say, “positive screening ESG opportunities may be easily available only in emerging markets.”

So why is it that the opportunity to achieve alpha appears to exist rather exclusively in the realm of emerging markets?

A big part of the reason lies in the fact that investors see companies with high ESG scores as having greater sustained viability in economic environments that are more distressed, inherently. Concern over said viability is not going to be as great in developed markets, where even those firms that do not place an explicit premium on ESG factors are still more likely, by virtue of the broad culture in which they operate, to fall on the right side of values-oriented considerations. An analysis conducted by Roberto Lampl, Head of Latin American Investments at Alquity Investment Management, as well as Niccolò Bardoscia & John Munge, MSc students at Cass Business School, and the results of which were published in the white paper “Does ESG Enhance Returns in Emerging and Frontier Markets?” seems to bear this out.

Part of the authors’ investigation involved looking at the effect that a company’s level of ESG disclosure, along with improvement in its disclosure posture, had on its risk-adjusted returns, and segmented the examination among three characters of geographical investment region: emerging markets; Middle East and Africa markets; and developed markets.

Emerging Markets (Risk-Adjusted Returns)

  Low ESG Disclosure Growth High ESG Disclosure Growth
High ESG Disclosure Score 2.0% 5.4%
Low ESG Disclosure Score 1.2% 3.1%


Middle East & Africa Markets (Risk-Adjusted Returns)

  Low ESG Disclosure Growth High ESG Disclosure Growth
High ESG Disclosure Score 2.8% 7.4%
Low ESG Disclosure Score 4.4% 5.9%


Developed Markets (Risk-Adjusted Returns)

  Low ESG Disclosure Growth High ESG Disclosure Growth
High ESG Disclosure Score 2.0% 5.4%
Low ESG Disclosure Score 1.2% 3.1%

Source: Robert Lampl et al., “Does ESG Enhance Returns in Emerging and Frontier Markets?”

Among their findings was that those companies based in emerging markets, along with those of the Middle East and Africa, that evidenced robust ESG disclosure and marked improvement in their transparency…clearly outperformed their low-disclosure/low-improvement counterparts.

Additionally, the findings show that improvement in ESG disclosure had a beneficial impact, in terms of risk-adjusted returns, on firms in these markets identified by the study as being both high and low disclosure companies.

Revealingly, the study illustrated that the benefits of ESG disclosure and improvements in ESG disclosure do not have the same sort of influence on performance with respect to companies based in developed markets, and attributes this reality to greater market efficiency, overall, as well as to, simply, a broader appreciation within developed markets for ESG factors and risks.

Nicolas Jaquier, an economist of emerging markets debt at Standard Life Investments, effectively connected the dots between ESG issues and investment benefit in a June 2016 piece for Pensions & Investments. While the explanation is rooted rather specifically in the viability of emerging markets sovereign debt to investors, the issues on which Jaquier touches are applicable to prospective investors in any asset class inside of emerging markets.

Declaring flatly that “a country’s creditworthiness is fundamentally dependent on its competitiveness and ability to sustain economic growth over the long term,” Jaquier identifies an array of ESG-related factors as being central to this sustainment, in addition to the usual macroeconomic considerations to which investors pay close attention. Saying that “institutional weaknesses and social issues can amplify macroeconomic fragilities,” he points out that the introduction of ESG variables into the equation not only allow for, but demand, that sovereign debt be evaluated in what he terms a “holistic” fashion.

In discussing how an avoidance of ESG-related issues can potentially prove troublesome, Jaquier suggests that Chinese GDP could well be adversely impacted by the massively-higher levels of environmental pollution that have resulted from its intensive period of economic growth, while those nations much further long in the evolution of ESG components within their economies are going to be far better insulated from any of a variety of threats to the natural order. By the same token, and more generally, Jaquier points out that weakness in governance – as frequently evidenced by foundational unsoundness and corruption throughout a governmental hierarchy – has a tendency to “lead to stunted development and lower social outcomes.”

The relatively diminished presence of these kinds of issues within more developed nations means that the opportunity for investors to capitalize on acute, strategic efforts at investing in genuinely ESG-aware nations, and the companies inside of them, is weak.

With respect to the matter of translating the problem of ESG issue avoidance to truly emerging markets, Jaquier points out that because of the wide variations in relative development even within that class of economy, there is an absence of any standardized inter-country approach, or even perspective, when it comes to ESG. As a result, investors are required to look carefully at those nations under consideration for investment and identify those with the most apparent ability to maintain economic growth and, from the standpoint of the sovereign debt investor, repay their obligations.

Jaquier specifically mentions Romania as an example of how devotion, newfound as it may be, to ESG values can aid in enhancing the investability of one country. He specifically mentions that nation’s successful efforts, since the Great (Global) Recession, at achieving both economic reform and a containment of corruption…as leading the way in improving the country’s ESG profile. Jaquier points out that while credit rating agencies may not as yet have fully rewarded the country for it accomplishments in this area, the performance of their sovereign bonds, relative the broader market, are a good indicator, nevertheless. Romania is still not technically an “emerging market” by some measures (in the views of FTSE Russell and MSCI, for instance) largely because the Bucharest Stock Exchange reflects too few companies with a robust free-float (read: “illiquid”), but the point is the capital market there is continuing to improve, due in no small way to the nation’s adherence to ESG values.

It remains to be seen if investing by way of an overt ESG paradigm will ever yield a significant benefit in developed markets. For the reasons previously noted here, it’s reasonable to suggest that it won’t; broadly speaking, more mature, efficient markets within countries that are considerably more evolved from an ESG standpoint, anyway, basically by definition do not allow for even a great deal in the way of a risk-avoidance benefit, let alone the achievement of true alpha through an ESG-oriented investment effort. That is, however, not the case in less mature markets, where there remains great disparities both nationally and on a by-company basis in adherence to ESG values. It is precisely these disparities that allow, for the significantly foreseeable future, prospective emerging markets investors to derive a definable benefit by applying an ESG overlay to their fundamental analysis of both maturing nations and the companies found therein.

The information contained here is for general information purposes only. The Financial Writer blog and Bob Yetman disclaim responsibility for any liability or loss incurred as a consequence of the use or application, either directly or indirectly, of any information presented herein. Nothing contained in this article, or any other article featured at this blog, should be construed as a solicitation or recommendation to engage in any financial transaction. You should seek the advice of a qualified professional before making any changes to your personal financial profile.

Comments are closed.

Blog at

Up ↑

%d bloggers like this: