Why emerging markets is the perfect place for impact investing
Why emerging markets is the perfect place for impact investing
Investors’ interest in understanding the impact of their investment decisions has never been greater. Nowhere is this more important than in emerging markets (EM).
The health crisis triggered by Covid-19 has been a reminder of the harsh realities that many people across the world face everyday. According to United Nations (UN) estimates, over 2 billion people do not have regular access to safe, nutritious and sufficient food. 2.4 billion people still lack access to basic sanitisation services, while 20% of children do not have access to formal education.
Many of the affected people live in EM, and the pandemic has exacerbated the existing challenges.
What is impact investing?
The essence of impact investing is the intention to generate a societal benefit, in combination with a financial return for shareholders and to measure the impact.
The size of the impact investing market is still very small, at around $715 billion at the end of 2019, based on estimates from the Global Impact Investing Network (GIIN). The potential for growth is significant, and is likely to be driven by investor demand to align their values with their investment goals.
Historically, solving these issues has often been left to philanthropy. But there is increasing consensus that market investments can achieve environmental and social, as well as financial goals.
Why invest in impact in emerging markets?
Nowhere is there greater need for the resolution of environmental and social issues than in EM. These countries are home to close to 6.6 billion people, equivalent to 86% of the world’s population, based on data from the International Monetary Fund.
And these countries are at greatest risk from the effects of climate change. Of the top ten cities most vulnerable to climate change, nine are in EM countries. Air quality is a concern across many emerging countries.
Governments globally are responding to these challenges, amid growing public concern. Most emerging countries have signed the Paris Agreement on climate change, but some governments have taken a selective approach with regards to environmental, social and governance issues (ESG). Emerging countries face the biggest challenges, and so the scale of the response required is significant, potentially requiring a review of a country’s economic model.
Without the sharing of technology from advanced nations, there could be negative implications for entire industries, with ramifications for employment and livelihoods. And where hurdles can be overcome, there is the issue of bureaucracy, meaning change can take place at glacial rate; or at least be delayed until the pressure to act is too great.
Public companies have a critical role to play. Not only through their products and services, but also by the way they manage their operations and their impact on the environment, and who they employ. These decisions can be taken more directly, and at a reasonably fast pace. The potential for investors to have an impact is therefore considerable.
EM companies in general are at early stages in the impact and ESG journey. As a result, there is a long-term opportunity for investors to participate. The nature of EM means that there is also a broad range of investment opportunities. Providing capital to companies which meet defined investment criteria enables them to grow sustainably, and to have a greater impact in the future.
How in practice does this work?
One of the core tenets of impact investing is that the societal benefit should be intentional and measurable, as well as material and sustainable.
These criteria are key to how we think about impact investing in EM. When it comes to investing in companies, we distil them to three key questions:
- Societal contribution: Does the company contribute to a better future for all? In order to confirm and identify the societal contribution, we link each company to a primary SDG.
- Sustainability: Is the business run for the long term? This underpins the sustainability objective. We only invest in companies that we believe treat all stakeholders fairly and run the business for the long term.
- Financial return: Is the stock a good investment? We are looking for companies which we believe will generate sustainable returns above their cost of capital.
To better measure the impact that companies have on society and the environment, we developed our own proprietary tools, including the award winning SustainEx.
As we mentioned, there is a journey to impact investing in EM. Engaging with companies and encouraging improved practices and disclosures is a fundamental part of this.
Establishing whether companies meet the above criteria, and their commitment to stakeholder outcomes can only be achieved through regular dialogue. Companies’ receptiveness to this engagement alone can be evidence of their commitment to operating in a sustainable way.
In EM, there is often a lack of available data. Bridging this gap is difficult without engagement. It also provides an opportunity to verify what is being presented by companies, avoiding the risk of greenwashing; where companies make bold claims but in practice do not live up to their promises.
Covid-19 has magnified the importance of impact investing in emerging markets
We see the potential for investors to have an impact and help solve some of the many global challenges as enormous. The UN SDGs provide a framework to underpin this process, and there is ongoing consensus among governments and companies globally as to its merits.
In EM, the impact of Covid-19 has only magnified this need. As the world exits the pandemic, environmental and social issues are likely to gain even greater focus. Better tools to analyse and monitor companies and their operations mean that the power to drive change is in the hands of investors.
Demographic changes are another factor which we expect to drive demand for impact investing. Specifically, the looming shift in economic importance as wealth moves into the hands of millennials and Generation Z. These generations are more attuned to issues such as impact and therefore more likely to demand that their investments are more aligned with their values.
The case for impact investing has never been stronger.
- Infographic: A snapshot of the world economy
- Video – The company using agricultural waste to power your car
- What makes a company a climate leader?
- Global Market Perspective Q4 2021: economic and asset allocation views
- China: the most radical climate reformer of all?
- How we are engaging on ESG in Asian real estate credit
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