Three in four emerging market nations are improving their ESG scores
- 56 emerging market countries are improving ESG scores, versus 16 that are deteriorating, NN IP ESG Lens shows
- High achievers Armenia, Croatia, Georgia and Malaysia improved fast over 2016-2019
- Integrating ESG factors into EMD investment processes provides a more holistic view of risks and opportunities
Integrating environmental, social and governance (ESG) factors into emerging market debt (EMD) investments is challenging but by investing responsibly in EMD, investors can benefit from strong returns while contributing to a more sustainable world. A growing body of academic research shows that improving ESG scores boosts risk-adjusted returns,* yet investors often fail to appreciate how emerging markets are doing this. To what extent are emerging markets raising their ESG game?
NN Investment Partners’ (NN IP’s) ESG Lens, a valuable tool for ESG integration across a broad spectrum of investment strategies, provides a single ESG score for each company or country, taking into account a wide range of data points. Looking at sovereign data, the ESG Lens shows that 56 emerging market countries are improving their ESG scores, which is over three times more than those that are deteriorating (16). Already high-achieving countries that improved rapidly over 2016-2019 include Armenia, Croatia, Georgia and Malaysia, while countries that came from a low base but significantly improved include Angola, Kenya, Pakistan and Papua New Guinea.
Marcin Adamczyk, Head of Emerging Market Debt, NN Investment Partners: “ESG factors can positively or adversely impact financial performance. On the sovereign level, they can affect economic growth, public finances, and borrowing costs, for example. Integrating ESG factors can therefore help us proactively manage risk and identify areas of possible concern as well as potential opportunities to secure better investment returns. For our EMD strategies, we apply ESG integration in all steps of the investment process, and we use engagement to pursue structural ESG improvements. The key is to focus on the journey – studies show that improvements as a result of structural reforms can lower risk premiums for EM sovereign issuers, as can better governance, environmental or social scores.”
NN IP has been integrating ESG criteria into its EMD strategies since 1993 and now structurally integrates all three factors (E, S and G) into its EMD strategies in an auditable manner. The ESG assessment process involves assessing a wide variety of factors and data points, covering topics such as corruption, transparency, emissions and standards of public health, among others.
Data issues are prevalent in emerging markets, hence NN IP uses big data supplemented by qualitative inputs from its analysts to produce country-level ESG scorecards that combine qualitative and quantitative assessments. One of the key inputs is the NN IP ESG Lens using sovereign data, which is based on two fundamental pillars, the ESG Stability Indicator and the ESG Development Indicator. To analyze companies, NN IP uses its EMD Corporate ESG Scorecard and NN IP ESG Lens using corporate data.
Marcin added: “The difficulty lies with the quality of the data and the ability to analyse it and reach the right conclusions.
This is where experience matters: you need to be able to assess the data and draw comparisons between countries. In this way, you can reward countries that are making progress and be cautious versus those that are deteriorating. It is important though to find the common denominator in all this data and make it usable in a forward-looking manner. That’s where experience and quality of management comes in.”
NN IP manages 18 billion USD in assets in EMD strategies*, which are all ESG-integrated. A detailed paper on NN IP’s ESG integration process within EMD has been published here. NN IP integrates stringent ESG criteria into 74% of its total AuM* in an structural and auditable manner, with the ambition to increase this to 80% by 2023.
*figures as of 31 December 2020
*Source: Berg et al, 2016, International Monetary Fund, 2017, Naoko, N & Lian, L., 2020; International Monetary Fund, 2017: The Effects of Data Transparency Policy Reforms on Emerging Market Sovereign Bond Spreads. Berg et al, 2016: Sovereign Bond Spreads and Extra-Financial Performance: An Empirical Analysis of Emerging Markets. Naoko, N & Lian, L., 2020: Measuring the Effect of Environmental, Social, and Governance on Sovereign Funding Costs.