EM Corporates: Emissions in Focus
Despite continued growth, Emerging Market Corporates (CEMBI) remain a misunderstood asset class. Often looked at through a simplistic lens, CEMBI is a highly diverse pool of bonds that incorporates ~800 issuers from ~60 different countries and is similar in size to both U.S. High Yield (HY) and Emerging Market Hard Currency Sovereigns ex-Quasis. While it is broadly understood that CEMBI has shorter interest rate duration than U.S. Investment Grade (IG) Corporates, stronger fundamental metrics than U.S. HY, and higher rating-adjusted yields than both, less understood is how CEMBI differs from a sectoral and carbon emissions perspective. We believe, based on information from the MSCI ESG database on relative emission generation across the three asset classes, that the assumption that CEMBI companies are much higher-polluting, although widely held, is incorrect. In short, while higher emitting from a carbon intensity perspective, CEMBI’s higher relative emissions is primarily a function of its sectoral composition (i.e., larger weight to industrial-oriented sectors) and the impact of just ten very-high-carbon-intensity credits. In looking at the underlying data, CEMBI is revealed as a more nuanced asset class that not only offers investors attractive rating-adjusted yield and diversification, but also comparable emissions exposure to other fixed income asset classes. Additionally, we find that CEMBI offers active investors substantial latitude to drive change in company policy and disclosure via engaged capital allocation.
Starting with the relative sectoral compositions, as shown in the chart below, CEMBI has a much higher exposure to “high emission” sectors relative to U.S. HY or U.S. IG. This gap is predominantly explained by the differences in the economic compositions of the underlying EM countries, inherent natural resource bases, disproportionate size of the natural resource companies, and overall economic development of the respective countries. Nevertheless, this difference significantly affects the aggregate carbon emissions and intensity of the CEMBI relative to other asset classes. Additionally, it contributes to a broader perception that CEMBI companies are generally less efficient from a carbon intensity perspective and that the overall asset class is systematically behind-the-curve when it comes to addressing emissions. However, the tilt towards higher-emission sectors obscures the differentiation that exists within each sector and what is happening at the company level. For instance, the underlying data shows that there are multiple sectors where CEMBI companies generate lower weighted average carbon intensities than either U.S. IG or U.S. HY (e.g., financials, pulp & paper).
Adding onto this, the underlying data also reveals that, relative to U.S. IG and U.S. HY, CEMBI’s emission risk is uniquely concentrated in a small number names, and when these are excluded, overall carbon intensity drops materially. This concentration in high-emitting companies is mostly driven by the prevalence of very large (partially) state-owned-entities and national champions, both of which are more common in less-developed economies. When we strip out the top 10 emitters, the weighted average carbon intensity of CEMBI falls ~35%. Additionally, when comparing the ESG policies, targets, and disclosures of blue chip CEMBI companies to those in the S&P500 or U.S. IG index, we find little difference: the top end of CEMBI companies are in the same league as developed market peers. In our view, investors are presented with an attractive opportunity to sift through the underlying companies and gain exposure to a subset of emerging market corporates that have much more in common with U.S. IG from a carbon intensity perspective than the aggregate CEMBI statistics otherwise suggest.
To conclude, while negative political headlines and aggregate statistics often dominate the narrative around emerging market corporates, CEMBI is a much more nuanced asset class that remains an attractive opportunity set for active investors. When adjusting for differences in sectoral composition and the small number of outliers, CEMBI is much closer to U.S. IG in terms of its carbon intensity. Additionally, the top-end CEMBI companies are approaching emissions in a proactive, intentional, and transparent manner very similar to what is found in U.S. IG. We find that there is currently ample room for active investors to lend to high-carbon-efficiency CEMBI companies while helping shape the policies and disclosure levels of the less efficient issuers through engagement with the management teams.
 “CEMBI” refers to the JP Morgan Corporate Emerging Markets Bond Index Broad Diversified
 $1,491b for CEMBI, $1,396b for Emerging Market Sovereigns ex quasis, and $1,632m for U.S. HY (JPM)
 CEMBI has >50% exposure to investment-grade rated companies (JPM)
 While there are multiple methodologies for calculating carbon intensity, we use (Scope 1 + 2 CO2 Tons Emissions / USD Million Sales) to remain consistent with MSCI’s database. Scope 1 emissions are direct emissions that result from a company’s owned and controlled operations (e.g., facilities, company vehicles). Scope 2 emissions are indirect emissions that result from the generation of energy purchased by a company. Scope 3 emissions, while not included in the traditional carbon intensity metrics, are other indirect emissions that occur in the value chain of a company. These are less reported, more difficult to measure, and often result in double counting when aggregating across sectors, regions, or asset classes.