Environmental, Social and Governance (ESG) in Emerging Markets
when we first laid out a research framework for investing in emerging market equities, we wanted to consider all factors that could affect a company’s profitability and value in the future – in other words, to think about the duration of a business and its worth. Duration as we used the term was a broad definition of sustainability which, while incorporating what is usually understood by “ESG”, was not limited to it. We wanted our research to consider all risk factors that could affect the value of our clients’ investments in the long term, including of course those arising from environmental and social issues, and corporate governance. Without making this broad assessment of future risks, how could we know what a fair price might be for a stock? And how could we understand the risks that we face as owners of businesses on our clients’ behalf?
Because we took this broad view of sustainability, our analysis was neither led by nor limited to specific emphasis on ESG as a separate element in our investment approach; ESG considerations were simply a natural and integral part of our fundamental research and our approach to investing. As a result, our fundamental portfolios have typically exhibited characteristics that stood up well to scrutiny from an ESG perspective. But given the growing attention to ESG issues, and the fact that clients are increasingly insisting on processes that address them, we decided it was important to be more explicit about what we do in this area and why. That is the objective of this brief paper.
Why think about ESG?
There are three very simple reasons we need to think about ESG:
- We have a responsibility to consider the broader consequences of our investment choices
- It is important to many of our clients
- It is entirely consistent with a long-term approach to investing
Some might argue that our only responsibility as managers of assets is to maximize returns for our clients’ portfolios. It’s a point of view, but I think this is a simplistic argument. We would not expect a business that we invested in to take this view, so it is hard to argue that we should do so ourselves. There is always a trade-off to be made between duration and return in the near term, but greater rewards are garnered by prioritising duration over short term outcomes, and this means thinking about sustainability in the broadest sense. The most impressive corporate managers that I come across are alert to this trade-off; they don’t just think about risks in a very broad way; they also understand the value of compounding and know that they must manage their companies in a way that promotes such outcomes; they tend to think about the long term; they have a natural interest in sustainability. We like companies that adopt this mind-set; and we should do the same ourselves. The investment industry cannot argue that it bears no responsibility for the choices that it makes beyond pure financial outcomes: to do so would be to ignore its broader social and economic function as an allocator of capital in market-based economies. This broader responsibility of our own industry is the first reason we need to consider ESG issues.