Part 6: Stewardship and ESG: An integral part of Emerging Markets investing
Kimon Kouryialas and Alastair Reynolds, Portfolio Manager for the Martin Currie Global Emerging Markets strategy discuss the unique challenges and opportunities that Emerging Markets present for ESG research.
We've developed a high level of trust for the companies that we invest in, and this allows us to play a really active role in connecting companies from across the world in pursuit of better ESG practices
Kimon: Hi I’m Kimon Kouryialas, I hope this message finds you and your family safe and well
Today I'm speaking with Alastair Reynolds, Portfolio Manager for the Global Emerging Markets strategy, managed at about Edinburgh office
Good morning Ally, it's fair to say that it's probably another bleak and miserable morning in Edinburgh.
Ally: Always is, whenever I'm around you Kimon, you can always guarantee it be bleak.
Kimon: Ally, my first question to you is why is ESG so important in terms of the emerging market strategy?
Ally: Yes, well there are two underlying drivers that really make ESG count. The first is that markets pricing expectations of long-term financial results, and the second is it savers really care about the kind of world that they live in.
The average company in the stock market has a valuation about 15 times this year's profits, that's the PE, so there's an expectation of Sustainability that's already built into today's price.
And then, as an institutional investor we are always aware that we are investing someone else's money to support their long-term plans. And of course, that individual saver cares about the future wealth, but they also increasingly conscious of the role that they can play an owner to shape the environment, society, that they're going to retire in to.
So, the investment decisions I make today on Environmental, Social or Governance factors have a real impact on investment performance and the future shape of the world
Kimon: And how do you take those ESG factors into consideration when investing?
Ally: We typically hold their investments for five years or longer, and we base our decisions on long term prospects, so ESG considerations they set the tone for how we identify investments, the price we're willing to pay for investments, and the way we engage with management of companies.
When deciding where to invest, before we commit any significant time to research a company, we first assess management's attitude towards governance and Sustainability. If we don't like what we see, we won't waste our time or your money considering it as an investment.
When we do take an idea forward, looking through an ESG lens gives us a good sense of how the company's positioned, they face risks and the opportunities. This improves our understanding of what businesses might be worth, and also increases our conviction when investing
Kimon: You mentioned briefly looking through an ESG lens. What do you mean by that, and what sort of skill set do you yourself or the team needs to be able to deliver on that concept?
Ally: An ESG lens, that's really about asking what are the material issues that companies likely to face as it attempts to grow over the longer term. Each company will have its own it exposure to Environmental, Social and Governance factors, but stopping to consider how each of these might impact the investment case is likely to be a source of valuable insight for us.
So, we engage with management, before and after, investing to understand how they are positioned for changes in ESG risk landscape. But also, to encourage management teams to improve performance wherever possible.
And we're really proud of the work that we do in this area, including sharing examples of good practise between companies, and by consistently voting in line with our principles of good governance.
Kimon: And in an emerging market world, what are the current issues that you are facing and our clients are facing when it comes to ESG?
Ally: Yeah, on the environment it's mostly about climate change, and within that risks and opportunities around decarbonization, but also increasingly about water scarcity as well. For companies operating, say in the power generation or extractive industries, areas that I look at, these present material risks. But it can also be great opportunities in areas such as renewables or water management.
So, that's Environment, but under the heading of Social, we tend to be focused on aspects of reputational risk and licence to operate. These are vital importance to companies with high public profile, or businesses that directly impact a lot of people. That could either be through high reliance on workers, or where commercial exploitation of resource impacts directly a local community.
And then in the governance area, we focus on the alignment of management with our interests as business owners. We're also focused on whether management teams have appropriate expertise and diversity to successfully execute their business strategy. So that's the E, S and the G.
Kimon: You and I have had many discussions with our client base around carbon footprint, so with decarbonization now becoming a global imperative, how for example can fossil fuel companies secure a place in your strategy?
Ally: Despite the best aspirations of asset owners, as a society of consumption, habits will leave us relying on fossil fuels for many years to come. And, that means it can still be a worthwhile investment so long as you do so with your eyes wide open
I view decarbonization as an inevitability and have focused my analysis on how individual companies align with the necessary transition to a lower carbon economy. What that means is I think that coal’s days as an investment are over, and in oil and gas we are focused only on companies enjoy low-cost reserves and don't over invest in further exploration. Luckily in emerging markets, that approach still gives access to investments with high current profitability but also high dividend payouts. So, it can still be an attractive part of our strategy
Kimon: And in emerging markets, what are sort of the unique ESG challenges that you face on a day to day basis, and a rolling year to year basis?
Ally: Well although the ESG factors that we face itself are universal, operating and emerging markets does definitely add some complexity.
So, first of all, we're investing across 30 different countries, and each of those has their own culture, national laws, institutions and languages. There's also a wide range of ownership and ownership structures, from state owned companies through oligarchies, to the more set visionary founder-led businesses of the digital economy. And each of these ownership structures must be considered within its own context, and really there's no one size fits all ideal that we look for.
But the very fact that we operate in such a complex field, that means that we can gain an advantage from identifying good ESG practises, but we can also play a really important role in improving corporate behaviour in the emerging markets as well.
We've developed a high level of trust for the companies that we invest in, and this allows us to play a really active role in connecting companies from across the world pursuit of better ESG practises. We have been doing that recently with, for example, banks from Peru - put them in touch with banks and Indonesia, and you end up with just really good conversations and much better outcomes
Kimon: Ally, I was reading with interest this morning, so back in March of 2009 there was a survey done by a global consultant in conjunction with the IFC, and I'd be interested in your points on these
- where it said that only 18% of emerging market strategies, and back then they had surveyed over 177 of those, raised any ESG concerns with investee companies.
- and the two big issues back then were lack of transparency and active ownership not being a high priority with investment managers
If you sort of think of where we are today, how would you sort of convey of what's happened over the last sort of 10 or 11 years in terms of ESG and emerging markets?
Ally: Yeah so, I think just picking up on the points you’ve made there, I mean that there certainly if you think about how your typical fund manager would be rewarded, the focus really had been on just hitting performance targets. There was very little importance given to pursuing the ESG agendas of the ultimate owners of those assets. So it's not surprising, but what you been saying to me, I guess it's only when you start to understand the value that that adds to ourselves as investors that you really start to see it playing a role in your own performance numbers.
But in terms of how that that landscape has been evolving, I think there's definitely been significant progress in accountability disclosure and engagement of ESG factors in general, and climate change has really risen from obscurity to become a factor that’s of universal concern.
So when I think back like 30 years ago when I first started investing, most EM companies were government controlled, and accountability for ESG factors really just sat with the government. They owned the companies, they took the responsibility. But then started to change in the 90s as businesses were privatised, boards started to bear a lot more of the responsibility for the ESG environment that they were working in, but also the decisions that they were taking as a management team. And quite frankly, a lot of investors just didn't get on the on that bandwagon and see that that change has taken place, and that this would actually really start to become a driver of differentiation between companies, but also in terms of performance outcomes
Kimon: And finally Ally, one more question. Have you seen any changes in terms of interactions with investee companies in a COVID-19 environment?
Ally: Well what's been quite nice is the C-Suite in companies are now much more available than they have been before and have been quite open to taking calls with people. So, getting out and they're not on the road, so the inefficiency of being on the road is away, with a lot more time to take a view and speak to investors.
But we've done there's we've used the opportunity to craft a letter to introduce our principles on investing and sent that out to companies. The idea there is that's arriving into companies at a time when the management, senior management, have got time to consider that, time to actually engage with you again, but also, we are increasingly aware that the momentum behind ESG is building. So that’s rising in near priorities as well. So that's one thing that we found this year - the availability of management and the willingness to engage on broader ESG issues - has been would be really encouraging during the COVID period.
Kimon: Well thank you very much for that Ally, it was it was a pleasure to speak to you
Ally: Great to catch up Kimon, all the best.
Kimon: And to our viewers out there, thank you very much for attending. Please stay on the line as the purpose of the next discussion is a group discussion actually, whereby Ally, David Sheasby Will Baylis, Megan Scott and myself will get together for a Q&A, where really what we want to talk about is a lot of the questions that our clients have been asking us over the last three to six months around ESG.
Thank you very much and take care
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