Assessing the viability and value of ESG investing in EM debt

Environmental, social and governance (ESG) goals, or responsible investing, have become an important consideration for many investors across the globe. Often, it is no longer enough for asset managers to focus purely on returns. Increasingly, investors now want to ensure that their capital is allocated in a responsible manner consistent with their values. In some instances, they hope to drive positive change with their investment decisions.
This dynamic, along with regulatory changes in some markets, has had, and will likely continue to have, a profound impact on the way capital is allocated. In our view, this focus on responsible and sustainable investing is a formalization of what has long been an important consideration for long-term oriented investors, especially in the emerging market (EM) space.
This paper provides an overview of the ESG investment landscape as it relates to EM fixed income. It is our view that the EM debt space provides a compelling opportunity for ESG-oriented investors, since such considerations are typically important in making good long-term investment decisions and avoiding the pitfalls that can be especially costly in the EM debt space. In addition, while the starting point for many EM entities, in terms of sustainability, is often significantly lower than in developed markets, the potential to drive positive change through one’s investment decisions is similarly greater.
ESG investing framework
One of the challenges with the rise of ESG, or sustainable investing, is that there are myriad views regarding what constitutes a “good” or “proper” approach to such investing, and even base line criteria. There is no single best approach, in our view, but we believe there are common principles necessary to formulate a credible ESG strategy:
• The strategy must have a clear set of investment criteria that are objectively measurable. This can be a simple best-in-class approach or a detailed set of positive, negative and exclusionary criteria, but there must be an objective standard for measuring compliance. This helps to avoid strategy drift and makes evaluating the success of the strategy more straightforward.
• Adequate resources are needed to conduct independent ESG analysis. Third party research providers, such as MSCI, are excellent resources that can provide useful data and a starting point for evaluation. However, given their breadth of coverage and dependence on easily accessible public data, we think their value from an investment standpoint is limited, especially in areas like EM debt, where obtaining relevant data can be more challenging. In our view, to deliver a value-added ESG strategy, an investment team must be able to conduct robust independent research that allows the assessment of an issuer’s position among peers in terms of overall fundamentals, specific ESG criteria and the issuer’s progress on ESG goals.
• We believe it is important to work with a manager who can deliver a strategy consistent with an investor’s values while offering potentially attractive riskadjusted returns. We view investors’ increasing focus on ESG-oriented capital allocation as a positive development, especially considering the environmental and social challenges facing the world. However, for such an emphasis to be sustainable, we believe such strategies must deliver compelling returns.