Thursday, April 22, 2010

GOVERNANCE ISSUES TAKEN MORE SERIOUSLY ALL AROUND THE GLOBE: THE RISE OF ESG INVESTING


Introduction
Today, LMG's Erik van Dijk chaired an interactive session entitled 'Opportunities in Emerging Markets' at the Institutional Investor's Nordic and Benelux Pension Fund Forum (Noordwijk, The Netherlands). Attending the conference were about 80 representatives of pension funds and asset management firms and some professional consultants like ourselves.

How ESG is becoming more important, also in Emerging Markets


We will provide you with more information about the interesting meetings in our next contribution. But today we will elaborate a bit further on one topic. It is clear that the interest in so-called ESG Investing (Environmental, Socially-Responsible, Corporate Governance) strategies is growing. Not just in Western markets, but especially in Emerging Markets. The times during which developing countries didn't care what their score was on rankings like Transparency International's CPI Index that measures corruption probabilities is far behind us. 

Transparency International; measuring ESG all around the globe

Globalization has made the world a smaller, and more transparent place. Large corporations, governments and central banks from emerging markets have learned their lesson: if you want to attract international capital and/or - in case of those emerging countries that do have a sufficiently large capital base to consider international investments (be they portfolio investments or foreign direct investments) - invest abroad yourself, it is good to be a trusted, credible party in the market. Corruption, lack of transparency or less ethical investments can be beneficial on a stand-alone basis but they are far less so when analyzing things in a multi-asset longer-term framework.

You can fool opponents once, but journalists will write about it. I.e. bad publicity. Also: whenever the Transparency scores are relatively low, investors will incorporate a risk premium in their discount rate as a result of which there is a tendency for firms to create lower ratings AND share returns than otherwise possible during other times.

 

Klijn (ABP): increased interest in ESG is an opportunity for growth and higher valuations in Emerging Markets
Robert Klijn, ESG specialist at APG Investments (the investment branch of Dutch pension giant ABP, one of the world's largest investors) went so far as to consider the probability of an increased attention for ESG factors and therefore a likelihood that they will be more actively followed within portfolios one of the key positive, opportunistic factors when analyzing emerging market nations and their investment opportunities. ESG filters on investment strategies have become very popular with pension plans in the Netherlands and Scandinavia. And adding this kind of filter to an Emerging Markets strategy will further raise the interest in that type of strategy.
 

How it all started: activist shareholders in the USA

ESG investing initially started in the USA. One of the impacts of ESG investing was a more active stand in shareholder meetings. Endowments and religious institutions were the first to come up with proxy proposals that shareholders could vote on. The original proposal plus managements advice were then presented to individual shareholders. When management was negative about a specific proposal the likelihood of it being adapted is relatively small. However, Time Magazine reports on Proxy Proposal season in the US this year and sees a trend towards an increased level of activism. The number of proposals is higher and the level of activism expressed in them is growing too. Understanding that the US is often a leading market, with the Rest of the World somewhat lacking Robert Klijn's analysis about big positive changes in this respect within Emerging Markets seems to be correct.

A better ESG profile will ensure a larger money inflow, better publicity and lower (overall) risk. The United Nations Principles of Responsible Investing (UNPRI) play an important role when trying to analyze in what direction things will go when dealing with larger local funds. 

 

Critics would say that it is hard to start something like that in an emerging market, because of a) a lack of reliable data ; and b) the level of depth of ESG information needed when not simply voting actively in an indirect way (by buying a firm when not dissatisfied about their activity from an ESG point of view or vice versa)). But as the US history of proxy proposals indicates, there are growing numbers of examples in which proxies were indeed successful. Time Magazine gives a bit more insights about that process.

Click this link here for a bit more details about the trends in US proxy voting.

LMG Emerge is a believer in this type of filters for institutional market participants that want to expand their Emerging Market exposure.

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