said Trujillo. “A lot of the ranking systems, whether World Bank or
Freedom House, are helpful in that they provide a bit of apples-to-
apples ranking across a broad spectrum of countries.”
Governance is the primary ESG factor to consider in emerging
markets, observers said, as better governance can help speed improve-
ments in environmental and social factors. Better governance also
tends to have the swiftest positive impact on investments, while social
and environmental factors have greater impact in the long run.
“Of the three, I believe coming from a traditional EM investor,
corporate governance is a critical factor in EM investments,” Su said.
“Investors are willing to pay a premium for better emerging-market
firms, and sometimes people are willing to invest in firms with better
corporate practices that could make up for a country’s weakness.”
A CIO can tilt or combine factors as needed, depending on the
mandates the asset owner applies, Jorgensen said. Different ESG
factors have greater or less statistical significance in explaining
change in spreads for individual countries.
Take Mongolia, where Global Evolution invests. This country
has rich copper deposits, and as a frontier market is making strides
in managing its resources better.
“There’s an interaction between environmental and governance
that can be a blessing,” Jorgensen said. “Governance plays a role in
the management of the wealth and revenues. Revenues in Mongolia
from copper production [flowing into] fiscal coffers [are] managed
well. The incentives of the institutions are much better than they are
in, say, Venezuela. There’s more transparency, less corruption, and
more enforced property rights.”
Another example is Georgia, an Eastern European country with
healthy business indicators that is easing conditions for the private
sector to do business. “What’s really important for these countries to
take off with growth and development is to have a flourishing private
sector,” Jorgensen said.
Argentina is an example of an emerging-market country with
good environmental and social factors, but where governance was
lacking, Jaquier said: “Argentina had a very well-educated labor
force, a lot that went abroad” during the presidencies of Nestor and
Christina Fernandez Kirchner. With new President Mauricio Macri
at the helm, Argentina’s governance is improving.
Turmoil Drags Down Turkey’s ESG Score
H2 2015 H1 2016 H2 2016
Source: Standard Life Investments
“They’re reviewing the whole procurement system, which was
an area of large-scale fraud and corruption, so it’s encouraging that
things are being done,” Jorgensen said. “We think that undoing
some of these practices will help put the country on the right tracks.”
Pressure from leading companies is pushing some emerg-
ing-market governments in the right direction, Su and Compere say.
“When we talk with corporate management about why they’re inter-
ested in ESG issues,” Su said, one reason is “they aspire to be global
leaders. Their market cap is still catching up, but they aspire to adopt
ESG best practices.”
Brazil provides another example. Stock exchanges in Latin
America’s biggest nation are requiring more disclosure in order to
get listed, which means more data availability and greater trans-
parency, said Compere. In the finance sector, Uno Banco has this
global focus. “They’re one of the few emerging-market companies
that do integrated reporting, which means they do ESG as part of
their disclosure,” she said.
Brazil continues to feel the repercussions of the Petrobras
scandal, which caused Standard Life to downgrade its ESG score.
However, Jaquier said he’s now turning positive on the country, since
the issue of corruption is finally being addressed, highlighting the
strength of the judiciary system, and the measures being put in place
to avoid another major scandal are encouraging. Moreover, investors
that incorporated ESG factors into their decision-making on Brazil
would likely have been unaffected by the scandal because lack of
transparency prompts ESG investors to avoid state-owned enterprises like Petrobras.
Monitoring ESG factors and watching political changes can
also give investors an early warning when the situation in a particular country is deteriorating, ahead of credit-agency downgrades,
Jaquier said. In Turkey, for example, managers at Standard Life
suspected the quantitative factors were out-of-date versus their qualitative judgment as to where the country was heading.
At the end of 2015, Turkey’s quantitative score was average;
widespread political turmoil boiled up soon after, including protests,
press crackdowns, allegations of corruption, concentration of power
around President Recep Tayyip Erdogan, and an attempted coup.
These issues were not reflected in the price of Turkish assets at the
time, however, and credit-rating agencies had not downgraded their
assessment of the country.
A closer look at Standard Life’s ESG score for Turkey, which
began to slip in the first half of 2016 (see Fig. 3, above), would have at
least partially cleared up this blind spot. “Turkey is a good example
of how paying close attention to some of these issues can limit risk
in your portfolio but also add value,” Jaquier said. Turkey’s situation and the rating agencies’ slowness to downgrade the country also
reflect the degree to which country analysis is still focused on macroeconomic data at the expense of other relevant factors.
“I’m not saying [the macroeconomic view is] not important,
because we also look at it,” Jaquier said. “For us, there’s a clear and
obvious value-add to taking these softer indicators into consideration—especially in the political and governance areas, which are
key behind a country’s willingness to address them.” CIO