Investment Insights

Global Emerging Markets

Through the ESG Lens

29 May 2020

Emerging markets have made great strides when it comes to ESG over the years, and there is now a constellation of companies which can go head to head with their developed-market peers.

Why ESG Matters

There is compelling evidence that ESG factors influence returns over the longer term. As bottom-up investors with a long-term philosophy we include ESG considerations when assessing companies as we believe these factors are critical to a company’s ability to generate sustainable long-term returns. Importantly, this assessment is conducted within our team by portfolio managers rather than managed by a separate ESG research team. In our experience, this ensures that these matters get a proper weighting in the conviction-building process. We work in close collaboration with Martin Currie’s Head of Stewardship & ESG, an experienced investor, who assists with voting policy and promoting best practice.

A Focus on Materiality

Our analysis and engagement efforts are guided by the materiality of issues in relation to each company. There is a growing body of research supporting such a focused approach, underlining a strong correlation between material ESG factors and returns. Over the years, we have developed extensive in-house resources, including industry frameworks which ensure that we focus on the most relevant questions. We consider a range of ESG factors every time we evaluate an investment and in every instance we assess how the company will be impacted by climate change.

We also recognise that no two companies are identical and as such we consider each company’s individual circumstances when assessing ESG performance.

Proprietary Governance and Sustainability Assessment

We have developed proprietary assessment frameworks to support our analysis across the different industries, countries and corporate cultures of emerging markets.

Governance sits at the heart of our analysis, as we believe this is a fundamental determinant of long-term performance and thus the sustainability of a business. Our governance assessment includes a review of ownership structure, board composition, remuneration, capital allocation, information disclosure, business ethics, management accessibility as well as how minority shareholders have been treated historically. We perform this assessment routinely for every company we research and distil our findings into a numerical score to reflect our conclusion on governance strength.

In our experience, good governance goes hand in hand with management of social and environmental risks, making it a good proxy for wider performance. The end goal is to develop insight as to whether a company will be a good long-term steward of our clients’ capital.

We use our sustainability framework to assess awareness, exposure and management of external risk factors. These include supply chain risks, environmental risks, regulatory risks and societal risks. As with governance research, we perform this analysis on every company we research and distil our findings into a numerical score to reflect our conclusion on business sustainability.

Importantly, we appreciate that companies are on a journey when it comes to ESG performance, so a firm that falls short of our expectations will not automatically be ruled out if we can see potential and a willingness to improve.

Martin Currie Governance and Sustainability Scorecards

Source: Martin Currie.

Engagement and Voting

Engagement and voting are two areas where we can make the biggest difference as active investors. Engagement allows us to improve our understanding of the opportunities and challenges companies face as well how management are adapting to these. Ultimately this leads to our investment decisions and voting decisions being better informed.

In our experience, there is a clear appetite for engagement and learning by emerging market companies. We leverage our extensive experience and understanding of ESG matters to help companies deliver improved outcomes from engagement. Our input is increasingly recognised by companies and we are regularly approached to provide input and support to improvement initiatives. Active ownership, through our engagement and voting, is a key element of how we discharge our stewardship duties on behalf of our clients.

ESG in Emerging Markets

Emerging markets have made great strides when it comes to ESG over the years and there is now a constellation of companies which can go head to head with their developed market peers. Indeed, recent research has underscored that emerging markets have caught up with developed ones when it comes to environmental and social performance, even if differences remain in terms of governance metrics. Investors should be cognizant of different ownership dynamics – government ownership is more prevalent, and while this may not be a problem, understanding the motivations and stakeholder alignment in such cases is important. Equally, family ownership is more common than in developed markets, but as studies have shown, investing alongside family owners can be a very beneficial long-term strategy.

Leading the Way

We observe a wide range of approaches to ESG both at a company level and between countries, and in a number of areas emerging markets lead by example. For instance, in South Africa the adoption of the 'King Report on Corporate Governance' has led to some of the best integrated reporting anywhere in the world, communicating a clear holistic approach to strategy, planning and how companies’ resources are used to create value. We are seeing growing adoption of integrated reporting in other emerging markets and many companies are reporting how their activities align with the UN’s Sustainable Development Goals (SDGs).

Our work also shows another area where emerging markets differ from US norms is on board structure. Here, emerging market companies generally have better age diversity and shorter-tenured directors. There is also far less controversy around executive compensation, due to the relatively modest pay packages typically offered to emerging market executives. While incentive schemes still require scrutiny, our focus tends to be on ownership structures and board composition.

When it comes to environmental issues, government policy will often play a role. Here it is important to highlight that many emerging market countries have reaffirmed their commitment to the Paris Agreement on climate change, following the US’s decision to leave. There is also progress amongst asset owners, as witnessed when four emerging market based sovereign wealth funds joined forces with two developed market funds to create the One Planet Sovereign Wealth Fund Framework. This partnership aims to accelerate the integration of climate change issues into the management of these large, long-term asset pools.

The appetite for engagement and learning shown by emerging market companies is often stronger than that exhibited by their developed market counterparts. They are also genuinely willing to listen and respond to investor input, a feature that enhances the influence we can have as stewards of our clients’ assets.

Room for Improvement

Whilst most companies in emerging markets recognise the importance of ESG, there is still much that can be done to meet the expectations of asset owners. Rather than poor underlying practice, it is often simply a matter of disclosure, with management lacking an awareness of the importance investors attach to these factors.

We are seeing signs of progress on disclosure with initiatives such the Task Force on Climate-related Financial Disclosure and SDGs bringing better consistency. We are also pleased to see the development of scenario analysis tools, with the Transition Pathway Initiative and the Paris Agreement Capital Transition Assessment both gaining traction.

Martin Currie and ESG at a Glance

The concept of stewardship is at the heart of our philosophy as active equity specialists, and ESG is a critical component of this, informing our research and engagement efforts. Analysis of these factors has been embedded in our emerging market team’s stock research process since the inception of the strategy. As a firm we routinely engage with businesses to improve awareness of sustainable business practices and to effect change. While most of our engagement takes place in private, we often join up with other investors when we deem this to be more impactful than acting alone. Recent examples of the latter include engagements on water risks in the agricultural supply chain, labour practices in the food retail sector, and cybersecurity.

As signatories to the Principles for Responsible Investment (PRI) we have committed to report on our activities in relation to responsible investing each year. We have consistently been highly rated by the PRI in their annual assessments and in 2019, for the third year running, achieved the highest possible rating (A+) in all top-level categories: ‘strategy and governance’, ‘incorporation’ and ‘active ownership’. We have also received the highest ranking (Tier 1) by the Financial Reporting Council for our statement of compliance with the UK Stewardship Code. Importantly, we believe in holding ourselves to the same standards that we expect of others and live our values through the management of our own business. This includes participating in industry initiatives to raise the profile of ESG issues, as well as sharing ideas about best practice.

 


Definitions:

Developed markets (DM) refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

Environmental, Social, and Governance (ESG) refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business.

The One Planet Sovereign Wealth Fund Framework was established in order to accelerate efforts to integrate financial risks and opportunities related to climate change in the management of large, long-term asset pools.

The “Paris Agreement” refers to the 2015 United Nations Climate Change Conference, COP 21 or CMP 11 was held in Paris, France, from 30 November to 12 December 2015. It was the 21st yearly session of the Conference of the Parties (COP) to the 1992 United Nations Framework Convention on Climate Change (UNFCCC) and the 11th session of the Meeting of the Parties (CMP) to the 1997 Kyoto Protocol.

The Paris Agreement Capital Transition Assessment or PACTA tool, analyzes exposure to transition risk in equity and fixed income portfolios over multiple scenarios, thereby helping to reduce information barriers on how climate scenario analysis can be done.

The UN Principles for Responsible Investment (PRI) is an international organization that works to promote the incorporation of environmental, social, and corporate governance factors (ESG) into investment decision-making.

The Task Force on Climate-related Financial Disclosures (TCFD) will develop voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders.

The Transition Pathway Initiative aims to define what the transition to a low carbon economy looks like for companies in high-impact sectors.

The UK Stewardship Code is a part of UK company law concerning principles that institutional investors are expected to follow. It was released in 2010 by the Financial Reporting Council, and is directed at asset managers who hold voting rights on shares in United Kingdom companies.

The UN Sustainable Development Goals (SDGs) are the blueprint to achieve a better and more sustainable future for all. They address the global challenges we face, including those related to poverty, inequality, climate, environmental degradation, prosperity, and peace and justice.

  • Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

    Important Information 

    All investments involve risk, including possible loss of principal.

    The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

    Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

    International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

    Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

    Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

    Important Information:

    The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

    The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

    This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.

    This material is only for distribution in those countries and to those recipients listed.

    All investors and eligible counterparties in EU and EEA countries:

    In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

    In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.

    In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH.

    Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

    All Investors in Hong Kong and Singapore:

    This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

    This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

    All Investors in the People’s Republic of China (“PRC”):

    This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

    This material has not been reviewed by any regulatory authority in the PRC.

    Distributors and existing investors in Korea and Distributors in Taiwan:

    This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

    This material has not been reviewed by any regulatory authority in Korea or Taiwan.

    All Investors in the Americas:

    This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

    All Investors in Australia and New Zealand:

    This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

    The aforementioned Legg Mason entities are wholly owned subsidiaries of Franklin Resources, Inc.