Hazards of responsible investing in emerging markets

Applying environmental, social and governance (ESG) filters when investing in emerging markets isn’t easy. Investors can come up against challenges such as lack of company transparency, varying governance structures, and a lack of clear and comparable ESG data.

But that doesn’t stop Sébastien Thevoux-Chabuel, ESG analyst and portfolio manager at Paris-based Comgest, and a speaker at the RIA Conference 2018 in Toronto.

During a session on responsible investment (RI) in emerging markets, Thevoux-Chabuel conceded that data “is not easily available” and there can be great risk when investing in such markets and applying ESG filters. That can include risk of corruption: while China is improving in this regard, he added, countries such as India have more issues.

There can also be labour rights and environmental protection issues, given the varying regulatory structures encountered, said session moderator Pierre McLean, a vice-president at Desjardins Investment.

Overall, you have to be “extremely careful” when analyzing emerging markets, said Thevoux-Chabuel, especially when you have investors who are engaged and willing to challenge portfolio choices.

The way he and his firm look at it, “no company is 100% perfect.” And if you haven’t found any issues, “you haven’t searched enough.”

The question is whether companies are moving in the right direction in terms of improving their practices. For example, Comgest has been measuring carbon footprints since 2010, and it also looks at water quality and biohazards when assessing the environmental impact of businesses.

Further, engagement versus divestment of businesses is crucial, he added, noting Comgest rates companies it invests in on a scale of one to four, with one being the optimal score. If a company has a rating of four, “you really want there to be improvements” in how it operates and in its relationships.

If Comgest sees evidence of positive change, companies’ scores can improve. For example, one growing company that Thevoux-Chabuel is invested in had a board of only three people when it was chosen. Based on its growth potential, he and his team suggested the company double the board’s size, and that occurred after “only three months of engagement.”

Thevoux-Chabuel said that the better a company’s ESG score, the lower its discount rate. This indicates that the company’s future cash flows, or prospects, are more highly valued than they were previously.

Don’t focus on divestment

In terms of sector exposure, the firm doesn’t favour divestment. Rather, it seeks to lower its exposure to sectors like oil and gas, mining, coal, construction and materials, defense, tobacco and banks.

Why are banks on that list? In emerging markets, they’re not transparent enough, Thevoux-Chabuel said. While you can assess their balance sheets, there may be issues with non-standardized accounting practices, or there may be other issues that you’re “not able to find on a balance sheet.”

Overall, “it’s hard to know where they’re making their money,” he said.

While there are hurdles, Thevoux-Chabuel said clients are highly engaged in ESG analysis and RI, and it’s an area his firm will continue to prioritize.

Also, for more on RI, read:

More responsible investment options for wealthy clients

Canada among OECD’s cleanest countries: Fraser Institute study

Why ESG analysis is critical: fund manager

The ins and outs of green bonds

Divest of fossil fuels for better returns: study