ESG Index dating back to 2013 to examine the impact of ESG factors.
The cap-weighted index tracks large-and mid-cap companies across
23 emerging-markets countries with high ESG performance scores
relative to their sector peers. In its three-year existence, Cambridge
found that it outperformed the MSCI World ESG Index by 367 basis
points, annualized. While style and sector factors account for some
of the difference, Cambridge attributed 199 basis points to stock-specific sources.
“The selection of stocks in emerging markets based on a broad
measure of ESG quality has meaningfully contributed to the index’s
outperformance over the three-year time period available for analysis,”
Chris Varco, senior investment director, concluded in the Cambridge
report. “Further, this stock-specific contribution has been consistent in
a period when emerging markets were quite volatile.”
When Cambridge tested pre-index data using live MSCI ratings
for select emerging-markets companies from 2007-11, the findings
were similar: the Emerging Markets ESG Index outperformed the
World ESG Index by 267 basis points.
“With the caveat that it’s a limited data set, it was exciting to
show that as long as there’s been enough ESG data to use, it’s been
crazy valuable,” Varco said.
What accounts for the greater impact of the “ESG effect”? “ESG
issues are core to a lot of what’s happening in EM countries,” said Eva
Zlotnicka, sustainable investment research analyst at Morgan Stanley.
“Anecdotally, we think that the dispersion among EM companies is
likely wider than what we see in many developed markets.”
When it comes to choosing countries to invest in, applying
governance factors is a good starting point, Moscardi said, since
strong governance factors aid transparency. “You can overlay it at
a country level if for no other reason than to set your expectations of
what you will find in that country,” he said.
Zlotnicka agrees, saying governance is the one component of
ESG that is important in all cases.
“It’s not always more important than environmental or social
factors, but is common throughout. I see it as a bit of a gating mechanism,” she said. For instance, a company with poor governance might
not be able to handle environmental or social issues—or, conversely,
to take advantage of positive environmental or social factors.
ESG Data Use Still in Its Infancy in Emerging
Even in the publicly traded corporate space, only in the past several
years has available research demonstrated the effect of ESG factors
on emerging-market equities, said Lauren Compere, managing
director/director of shareholder engagement at Boston Common
Asset Management. ESG factors are likewise little used by most
investors in emerging-market sovereign debt markets, Jaquier noted.
For frontier markets, that’s even more of an issue, said Ole Hagen
Jorgensen, director of research at Global Evolution, who also chairs
an advisory committee on credit ratings for the United Nations Principles for Responsible Investment.
But recent turmoil in some of the biggest emerging markets is
creating more demand for ESG data as an indicator of stability or
instability in the social and political realms.
Jorgensen creates models to examine changes in hard currency
spreads, using a combination of public and proprietary ESG data.
The model includes 10 variables; nine are standard economic factors,
and the tenth a composite of ESG indicators.
The model shows that 49% of market variation in frontier
and emerging-market bond spreads is explained by economic and
financial fundamentals. Adding ESG factors increases the explan-
atory power to 54%, Jorgensen said. “That’s a 10% improvement,
more or less, of how our models can inform us of what looks to be
undervalued or overvalued,” he said. “That’s a lot, and that 10%
comes from ESG. So nobody can convince me not to include ESG
dynamics. It gives us more information for the investment process.
It’s as simple as that.”
Recent events are making these effects harder to ignore. “ESG
in emerging markets is getting more attention [particularly with]
governance,” said Jason Trujillo, senior analyst at Invesco Fixed
Income. “Most notably, you can highlight the issue of Russia and
Brazil.” Russia’s annexation of Crimea and its possible interference
in elections in the US and elsewhere via hacking into computer
systems, which reinforced longstanding distrust of the govern-
ment, are examples, as is the Petrobras kick-back scandal that led
to the impeachment and removal of Brazil’s then-President Dilma
improvement leads to
improvement leads to
spread tightening in
in Global Evolution
of a notch
times bigger effect on GDP
growth per capita in emerging
vs. advanced economies
ESG Dynamics Matter for Frontier Returns
Source: Global Evolution calculations. ESG proprietary ratings based on data from the World Bank and Verisk/Maplecroft.