- Good Money Week starts today
- Country-level ESG risks can significantly impact the stability and growth potential of investments.
- Developed countries tend to enforce stringent environmental regulations.
- Emerging markets are often characterised by weak institutions, corruption and political instability and are more vulnerable to climate-related events.
- Why it’s still worth considering an investment in emerging markets
- Two fund ideas for risk-conscious investors
Dominic Rowles, Lead ESG analyst, Hargreaves Lansdown:
“Countries that struggle with environmental degradation, social inequality, or poor governance can create an unstable investment landscape, leading to a volatile regulatory regime, civil unrest, or economic downturns that negatively impact returns. When people think about ESG risks, they generally think about the amount of carbon emissions a company spits into the atmosphere, or how senior managers are incentivised. But country-level ESG risks can be just as important. They can significantly impact the stability and growth potential of investments within those nations.
Environmental risks
Wealthier nations usually have the resources to invest in sustainable infrastructure, clean energy and new technologies to mitigate environmental risks. Countries like Norway, Germany and New Zealand are leading the charge in switching to renewable energy sources to reduce their dependence on fossil fuels. Developed countries also tend to enforce stringent environmental regulations, thereby helping to manage risks like climate change, pollution and biodiversity loss. Wealthier countries can also better adapt to environmental changes. The Netherlands, for instance, has invested billions in flood defences and water management systems in response to rising sea levels. Others have developed early warning systems which help them to prepare for natural disasters and reduce the human and economic costs. In contrast, emerging economies are often more reliant on industries like agriculture, which makes them more vulnerable to climate-related events. Nations in South Asia, for example, face significant risk of droughts, floods and rising temperatures, which can devastate crops and livelihoods.
Social risks
Social factors like education, healthcare, and community relations are crucial for building a healthy, motivated, and skilled workforce. Scandinavian countries, such as Sweden and Denmark, are renowned for their robust welfare systems, which help reduce risks like inequality and health crises. Less developed countries often face high levels of poverty and inequality, exacerbating social tensions and hindering economic growth. This instability, combined with weaker healthcare and education systems, makes these regions more vulnerable to crises and less attractive for investment. For example, several African nations have struggled with high levels of poverty and weak public services, making it challenging to seize economic opportunities.
Governance risks
Wealthier countries typically have more established institutions and regulatory frameworks which help ensure transparency, accountability and the rule of law. The UK is home to one of the oldest democracies on the planet, and along with other developed economies like Japan, Australia, New Zealand and many of the Scandinavian countries, it often ranks among the best governed countries worldwide. This helps create a stable and predictable business environment and attract foreign investment. Wealthier countries also have the capacity to enforce anti-corruption measures and protect property rights.
Emerging markets are often characterised by weak institutions, corruption and political instability. These issues can create an unpredictable business environment and can also lead to a vicious cycle where poor governance undermines development, worsening social and environmental problems. In countries like Bangladesh, corruption remains a big issue and can divert resources from critical projects, while political instability hampers long-term policy implementation. It remains to be seen how ongoing political changes in the country will impact its long-term prospects.
Why it’s still worth considering an investment in emerging markets
Despite the increased risks of investing in emerging markets, we still think some exposure can be a good idea for many investors. Emerging markets are the engine of global growth and home to some of the most dynamic economies on the planet. They’re hotbeds of innovation and technology is an increasingly important part of what they do. From smartphones and IT services to some of the world’s biggest online shopping platforms. However, it’s important to take steps to mitigate the additional risks of investing in emerging markets by investing for the long-term and diversifying your investments across many industries and countries.
Two fund ideas
For investors who don’t want to take the risk that comes with investing in emerging markets, we think the Legal & General Future World ESG Developed Index could be a good option. It aims to track the performance of the Solactive L&G ESG Developed Markets Index and is made up of about 1,400 companies based across the developed world, including the United States, Japan, the UK and Europe. The index increases or reduces the size of its investment in companies based on how they score on various ESG criteria, from the level of carbon emissions to the number of female board members and the quality of disclosure on executive pay. It avoids investing in companies involved in controversial weapons, and those with significant involvement in tobacco, civilian firearms, thermal coal and oil sands. Likewise, for continuing violators of the UN Global Compact Principles. The fund also aims to reach at least a 7% reduction in carbon emissions per year until 2050.
For those comfortable with emerging market risks, the Legal & General Future World ESG Emerging Markets Indexcan complement the Developed Markets Index. It applies the same investment process, but tracks the Solactive L&G Enhanced ESG Emerging Markets index, which focuses on regions like Taiwan, China, India, South Korea and South Africa. The fund offers plenty of diversification too, investing in over 1,700 companies spanning industries like financial services, technology and Pharmaceuticals.”
Want to learn more?
This week is Good Money Week, a national campaign promoting responsible investing. We’ll be marking Good Money Week with a series of articles designed to help you assess how ESG-related risks could impact your portfolio. For more information on ESG integration and other responsible investing approaches, visit HL’s Responsible Investment hub. It includes a range of tips and tricks for responsible investors, including fund ideas.
