ESG Approach to Emerging Markets Fixed Income Investment

A decidedly modern approach to portfolio diversification, enhancing emerging-markets fixed-income (EMFI) investing with environmental, social and governance (ESG) factors is much more than a buzzword or a strategy du jour. Rather, it's quite possibly the ultimate expression of responsible investing: ensuring that all allocations, irrespective of geographic location or local politics, adhere to uncompromising standards of ethics, purpose, and mindfulness.

Through this lens, ESG investing doesn't just filter out the potentially unsavory; by shifting the focus from me to we, it strives to complete the transition from solipsistic profiteering to shared prosperity. Yet, even with the best of intentions, ESG must be concurrently reflective, adaptable, and lucrative in order to secure a place in the EMFI matrix - enduring relevance, indeed, must be earned.

A Seminal Treatise That Still Resonates

Often considered the manifesto of the ESG movement, the UN Global Compact's groundbreaking document "Who Cares Wins" strove to "develop guidelines and recommendations on how to better integrate environmental, social and corporate governance issues in asset management, securities brokerage services and associated research functions."

That's an ambitious objective, to be sure, and one might question the relevance of a document authored back in 2004. Nonetheless, I would recommend the tenets of "Who Cares Wins" as universally applicable across time and region, with specific implications for EMFI investing.

For instance, emerging-market investors would be well advised to ensure that they're only supporting economies that "are not complicit in human rights abuses," "support and respect the protection of internationally proclaimed human rights within their sphere of influence," and "all forms of forced and compulsory labour."

Others of the document's principles recommend solely investing in economies that seek to abolish child labor, promote environmental responsibility, recognize the right to collective bargaining, eliminate discrimination in employment, and combat bribery and extortion.

By revisiting "Who Cares Wins" and incorporating its foundational concepts, the EMFI investing community can work towards shared objectives while more readily identifying emerging-market opportunities that advance the EMG cause, thereby advancing EMG as a mainstream component of EMFI rather than a fringe or experimental element.

The Investor as Advocate

Before such mainstreaming can truly occur, however, more than a manifesto will be required. Ultimately, what's needed is a reimagining of the EMFI investor's role: are you an agent of change, or just an opportunistic bystander?

Terms like "activist investor" need not be derogatory in the EMFI domain, especially if influential investors and funds are willing to take the lead in changing the perceived purpose of EMG allocation. Subjecting target companies and countries to traditional socially responsible investing (SRI) screening processes isn't enough; today's EMG investor in the EMFI context must actively seek reform, effectively voting and thereby influencing with his or her shares.

Thus, as an example, a group of EMG influencers - or conceivably, even a lone investor, given enough clout - could appeal to a known developing-market polluter to curb its environmental footprint. In so doing, EMFI investors could effect change for the better while promoting and normalizing EMG-enhanced approaches to emerging-market investing.

Broadening EMG's Appeal

While the EMG approach should theoretically be an end in itself, making it a larger and better accepted part of EMFI means demonstrating that investors will accrue tangible benefit from it. If EMG isn't a win-win for all stakeholders, broad adoption among the emerging-market investing niche is unlikely.

Fortunately, compelling evidence of EMG's benefits is freely available. For example, a pair of research reports published by Bank of America found that "those companies ranking highest in ESG criteria tended to have consistently lower future stock price volatility and higher average subsequent returns on total equity compared to their lower-ranked counterparts" and that "investors who held stocks with above-average environmental and social scores would have avoided investing in 90 percent of companies with post-2008 bankruptcies."

Taking a broader view, a meta-analysis of more than 2,200 unique empirical studies, published in the Journal of Sustainable Finance & Investment, determined that "[r]oughly 90% of studies find a nonnegative ESG-CFP [corporate financial performance] relation. More importantly, the large majority of studies reports positive findings." The authors emphasize that "the positive ESG impact on CFP appears stable over time" and, speaking directly to EMFI investors, observe that "the Emerging Markets sample shows... a considerable higher share of positive outcomes over developed markets."

It's also encouraging to note that the acknowledgment of a causal link between EMG and outperformance exists and appears to be growing. Indeed, a survey from RBC Global Asset Management found that "[m]ore than 70% of institutional investors use ESG principles as part of their investment approach and decision-making process" and that "[a] positive performance impact (mitigating risk and enhancing returns) is now the top-cited reason for incorporating an ESG-based approach."

Going All In - for the Right Reasons

EMFI investing has a unique set of challenges, as does an EMG approach to asset management. Combining the two domains requires extra due diligence and perhaps a more active role, but enterprising emerging-market investors are increasingly willing to rise to the occasion and answer to a higher calling: enhancing returns and, in the process, enhancing the world.

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