“If you want your investments to help mitigate climate change, you have to be invested in emerging markets.” -- “Emerging market companies: Eyeing a sustainable future?” Candriam Investor Seminar, June 2022
Paulo Salazar - Head of Emerging Markets Equity
Galina Besedina - Portfolio Manager and Senior Analyst
Hien Nguyen - ESG Analyst
The question for asset managers is how to steer capital in the direction of those companies that, by their activities and example, have the ability to push emerging markets towards a more sustainable future. Finding the right investment criteria to identify such companies is not an easy task for international investors, given emerging markets’ dismal sustainability record.
Linear[1] consumer expansion
While population growth in developed markets has more or less stabilised over the past few decades[2], emerging markets of Asia and Africa have been responsible for a global population growth explosion. At the same time, urbanisation is fuelling the formation of a large and relatively wealthy middle class, together with all of its “un-circular”[3] habits of consumerism, such as constantly upgrading their smartphones, wardrobes fridges and cars with new models and fashions.
And while there are obvious bright spots like solar panel production, they represent a tiny part of the overall manufacturing base which is, in contrast to the West, relies on coal to supply it with energy. Emerging markets account for 76.8% of global coal consumption (the most carbon intensive energy source), with China contributing about half. Power generation accounts for 72.8% of coal usage, and industrial uses, such as coking coal for steel production, represent another 21.6 percent[4].
Inability to grow sustainably?
As we wrote last year[5], companies based in emerging economies increased their emissions by an average of 46% between 2015 and 2019, while those based in developed economies, mostly North America, Europe and Japan, reduced their emissions by 14% over the same period.
The worst ten emerging markets’ corporate contributors to global GHG emissions are responsible for 2.8 billion tons of annual CO2 emissions, which is about the same as annual emissions of all of the 27 EU member states combined.
While developed markets have been steadily reducing their carbon footprint, the increase that emerging markets produced over the same period had resulted in carbon emissions increase globally (see Figure 1).
Figure 1: Cumulative CO₂ emissions by world region
Cumulative carbon dioxide (CO₂) emissions by region from the year 1750 onwards. Emissions are based on territorial emissions (production-based) and do not account for emissions embedded in trade. This measures CO₂ emissions from fossil fuels and cement production only – land use change is not included.
Source: Global Carbon Project. (2021). Supplemental data of Global Carbon Project 2021 (1.0) [Data set]. Global Carbon Project. https://doi.org/10.18160/gcp-2021 Andrew, Robbie M., & Peters, Glen P. (2021). The Global Carbon Project's fossil CO2 emissions dataset [Data set]. Zenodo. https://doi.org/10.5281/zenodo.5569235
So, in this clearly challenging environment, how do investors find the companies in emerging markets with high sustainability ratings?
ESG Integration Supported by Country, Sector and Frameworks
Candriam has developed a rigorous and specific Emerging Market ESG analysis process which recognises the complexity of emerging market issuers. This draws on our Country, Sector, and Corporate ESG frameworks.
Apart from the sustainability challenges we discussed above, emerging market equities represent some of the most diverse, complex and less researched investment areas within their asset class. In general, company transparency is less standardised, information is less readily available, market structures are less developed, and investor access may be lower. For us, this is partially mitigated by a large-cap bias in in our portfolios. As many of these companies are more established, global leaders of their industries, their investor bases are typically more sophisticated and demanding.
The ESG Frameworks: Analysing Country, Sector and Corporate ESG Risks and Opportunities . . .
Given the wide disparities among the nations in which these firms operate, we find assessing the ESG risk of the countries in which firms are based and operate can provide substantial investment insight.
Our core company [link to Transparency Code] analysis framework analyses companies across two broad ranges of factors, Business Activities and Stakeholder Analysis (figures 2 and 3). We also avoid certain precisely defined controversial activities such as manufacturers of cluster munitions, thermal coal and tobacco.
Figure 2: EM ESG Corporate Approach
Source: Candriam, 2022
Figure 3: Candriam Business Activities ESG Framework
Source: Candriam, 2022
Opportunities . . .
Given our long history of specific ESG frameworks, the integration of ESG trends in our investment process has become a natural part of our way of thinking.
Analysing the ESG challenges and opportunities of, for example, healthy living and wellbeing, is inseparable from our search for companies which benefit from Demographic mega-trends. When these Demographic trends lead us to consider human capital and employees as corporate stakeholders, one can see how ESG and profit are truly integrated given how the treatment of employees fed into business continuity and profits for so many firms during the pandemic. The examination of Resources and Waste lead easily to obvious areas such as battery materials and battery recycling, as well as to less obvious but related businesses. Climate change is both an ESG factor, and a growth path, for a range of companies including less-obvious data suppliers, and suppliers of intermediary products and services.
Company Analysis – After screening about 1,700 companies of the broadly-defined EM universe using our Controversial Activities review and Norms-based analysis, we construct an investible universe of approximately 700 companies which our ESG team's analysis shows are the best able to address the opportunities and risks of sustainability challenges.
To determine the best-positioned companies we apply two pillars of sustainable fundamental analysis -- Business Activities and Stakeholder Analysis.
Closing the Circle
While we have laid out our process as a line for your understanding, every day it is a dynamic and interactive process. Every part of our ecosystem is based on our conviction that companies which embrace sustainability-related opportunities and challenges in combination with financial opportunities and challenges are the most likely to generate shareholder value.
With 25 years of emerging market equities investing (15 of them also running sustainable portfolios) and over a quarter of a century in ESG investing, this is not a set of Lego blocks snapping together. It is a truly integrated way of looking at things. It is no accident that the megatrends and pockets of growth we seek mesh so well with the ESG advantages we identify.
Risk factors to investing in Emerging Markets Equities or Sustainable EM Equities include risk of capital loss, equity risk, foreign exchange risk, emerging countries risk, ESG investment risk, sustainability risk, liquidity risk, risk associated with derivative financial instruments, risk associated with Chinese A Shares, counterparty risk, risk of changes to the benchmark index by the index provider, risk related to external factors, hedging risk of the share classes.
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[1] A linear economy traditionally follows the “take-make-dispose” step-by-step plan. This means that raw materials are collected, then transformed into products that are used until they are finally discarded as waste. Value is created in this economic system by producing and selling as many products as possible.
[2] https://www.gapminder.org/data/documentation/gd003/ ; https://population.un.org/wpp/Download/Standard/Population/ ; https://dataportaal.pbl.nl/downloads/HYDE/
[3] A circular economy is a model of production and consumption, which involves sharing, leasing, reusing, repairing, refurbishing and recycling existing materials and products as long as possible.
[4] https://blogs.imf.org/2020/12/08/a-greener-future-begins-with-a-shift-to-coal-alternatives/#:~:text=Today%2C%20emerging%20markets%20account%20for,production%2C%20represent%20another%2021.6%20percent.&text=Phaseouts%20from%20coal%20often%20take%20decades.
[5] https://www.candriam.com/4ac33c/siteassets/medias/publications/sustainable-investment/op-ed-david---emerging-market-companies-hold-the-key-to-our-climate-future/2021_11_em_climate_en_web.pdf