Despite being home to only 15% of the world’s population, developed countries represent over 40% of the world’s GDP. However, with most of the 2 billion people projected to join the middle class by 2030 residing in emerging markets, this balance is changing.
India and China combined are expected to represent 66% of the global middle class in just over a decade. While the increased spending power that comes with the growth of the middle class is a great narrative for us as emerging market investors, there is a simple question that shouldn’t be forgotten – what is the negative impact of these trends?
The evolution of the developed world has come at a huge cost to the environment, and we remain the largest environmental offenders from a per capita perspective. Increasing standards of living and growing populations in emerging markets will inevitably worsen the environmental crisis we face. But developed nations cannot expect their emerging neighbours to curb their middle class aspirations in exchange for reversing the planetary destruction caused by the former. Ending inequality must be addressed concurrently with strategies to urgently tackle climate change, loss of biodiversity and other factors threatening people and the planet.
The role of investors
To support sustainable economic development, a new investment approach is required. This must be one whereby company performance is not solely calculated based on traditional financial metrics but also on actions to incorporate material environmental, social and governance (ESG) factors into long-term business strategy. Such an approach would help to minimise risks and maximise opportunities from sustainable development trends.
We launched our first Responsible Global Emerging Markets vehicle in early 2010 with this in mind. It was one of the first emerging markets funds that sought to integrate ESG considerations into the investment process. It was challenging to launch such a fund at a time when ESG reporting in emerging markets was very poor and companies were not used to (nor particularly open about) discussing ESG issues. However, we rose to the challenge, backed by Columbia Threadneedle Investments impressive heritage in running ethical and ESG funds, and the strength and expertise of our Responsible Investment and Emerging Market investment teams. These have proved to be robust foundations that we have built on to improve the strategy’s ESG profile over time.
Highlights from 10 years of responsible investing
We’ve learnt a lot since we launched the strategy – discover some of the biggest lessons below:
- It pays to hold for the long-term: Companies can display elevated returns on capital in the short term, but over time the forces of capitalism tend to compete these returns away. We invest with a long-term horizon and as such our analysis of a company’s quality focuses not just on its current economic moat, but crucially, the sustainability of that moat over time. A long time horizon also allows us to build trust with the companies we own facilitating the constructive dialogue needed for effective engagement.
- Thoughtful ESG engagement and voting are critical to running the strategy successfully: Since the strategy’s inception, we felt that it would not be possible to run an emerging market ‘responsible’ fund without this element. Engagement has allowed us to obtain the information required to properly screen and assess companies’ ESG practices and performance, whilst seeking to influence positive change. In fact, our experience engaging companies in the strategy has been instrumental in enhancing our engagement capabilities across emerging markets. Ultimately, active ownership helps us preserve long-term shareholder value and enhance long-term returns.
- Focus has shifted from excluding companies with unsustainable business models to identifying companies positioned to benefit from or contribute to sustainable development: in the context of emerging markets’ disproportionate exposure to environmental and social trends compared with developed markets (think issues such as technology, demographic shifts and climate change), companies well placed to respond to these and other sustainability trends may have longer runway for growth.
- The importance of measuring and reporting on impact linked to UN Sustainable Development Goals (SDGs): it’s not enough to say we intend to support sustainable development – we must monitor and measure the impact our investments have. Producing an annual impact report for the strategy allows us to assess how our holdings contribute to addressing sustainable development challenges, from ensuring gender equality to tackling climate change.
ESG engagement in 2020
In 2020, we engaged with 31 companies, representing 87% of our Responsible Global Emerging Markets portfolio by value, with the aim of improving their management of material ESG issues.
Our holdings at a glance
On the investment front, we are proud that quality companies such as Taiwan Semiconductor Manufacturing Company and Tencent have been in the strategy since inception, and we have been invested in other top 10 portfolio holdings HDFC Bank and AIA Group for most of the strategy’s duration. Of course, not all our investee companies have done as well, but continued improvements result in identification of many more potential ideas. We continue to discuss lessons learned to ensure transparency and accountability to our clients.
Our overarching goal
In addition to the goals of profitability and growing the business, our overarching strategy goal has always been to allocate capital where it can make a difference beyond profits. This continues to be the case, as we seek great companies that can satisfy all stakeholders and not just focus on shareholders. When we started the strategy, clients would ask, “How much will ESG integration cost us in terms of performance (given certain stocks and sectors would have to be excluded)?”. We’re pleased that today the question is instead, “How much added value is coming from ESG?”. As stewards of our clients’ capital, allocation comes with responsibility, including an understanding of the value-add it has in the societies in which it is deployed. Deploying capital with efficiency and purpose will not only benefit our existing investments tremendously, but will help make the world a better place.
10 years on
In 2020, we leveraged our experience to expand our responsible fund range, launching the Responsible Asia and Responsible China A-Shares equity strategies. These again combine LGM’s investment team’s China A-shares and Asian equity investing experience with the immense knowledge of the CT Responsible Investing team, which is key to the future potential successes of these offerings.
