Evaluate ESG factors when investing in emerging debt


  • There are opportunities in ‘long term improvers’ as these emerging markets (EM) need investments for growth, jobs and stronger foundations.
  • Selectivity is key: MS include those who improve living standards, political frameworks and democracy, but also those who ignore pollution controls, face growing social tensions or institutions in crisis
  • For investors, a environmental, social and governance oriented approach Criteria (ESG) correspond to ethical investment, long-term position and risk mitigation
  • The combination of alpha potential and ESG ranking can produce an ESG oriented portfolio without limiting diversification or the set of alpha

Barely ten years ago, most emerging countries facing fragile political, social or economic situations were low-income. Today, measures such as human development indices show significant progress, allowing many countries to achieve middle-income country status. Going forward, some of the poorest countries with the lowest ESG scores may actually register the greatest improvements. This could make investing in their debt an attractive opportunity.

Aim for “long-term enhancers”

Without a doubt, many emerging countries are starting from a (lower) base. This provides many with “fruits at hand” – areas that can be improved relatively easily. These areas include ESG aspects such as greater environmental efficiencies (the “E” of ESG), safeguarding social assets (the “S”) and improving government institutions (the “G”). These are precisely the countries that are most in need of long-term, responsible investment to stimulate economic growth, create jobs and strengthen their economic foundations.

We believe these countries represent the best set of “long-term enhancers” capable of generating disproportionate growth and asset gains for patient investors. Demographic trends and a growing middle class are driving increasing demand for consumer goods, infrastructure, services and agribusiness. This should boost economic growth – as well as prosperity and well-being.

Why include these opportunities in an ESG framework?

We believe there is a moral imperative for investors and asset managers to concentrate fiduciary assets in sustainable investments. This reflects our belief in ethical investing, acting as long-term investors and mitigating risk, for ourselves and our clients.

As said, there is no longer a single EM support. From an ESG perspective, some countries improve living standards, policy frameworks and democracy, while others regress as pollution controls are reversed, social tensions rise, or institutions fall into crisis. . They are not necessarily the same groups. Here, an ESG framework helps us separate the wheat from the chaff. Such a selective approach also sends a clear signal to emerging debt issuers that investors are focusing on sustainability.

Overweight champions and avoid backsliders

In short, there are two ways to generate alpha for investors: by overweighting emerging market champions (the “long term improvers”) or by underweighting traps, laggards and backsliders. We believe that investing in emerging markets is not just about finding the best markets; it is also to avoid the worst. Long-term sustainability, in our opinion, is synonymous with minimizing exposure to crises or “blasts”. This requires an innovative and nuanced implementation of ESG research.

As a pioneer of ESG investment approaches, for almost two decades we can now count on a highly qualified ESG research team, we have access to hundreds of data sources covering all categories of ESG ratings, and we have the ability to adapt to the nuances and dynamic realities of emerging countries.

Use a multifactor model

Our sovereign debt ESG model assesses the ability of governments to best protect citizens’ interests and deliver appropriate ESG goods and services. However, making this assessment can be a challenge given that for the 90 emerging countries in which we invest, a full set of data is not always available and certainly not always on a regular basis.

By circumventing this constraint, we examine emerging debt for both economic factors and ESG criteria. These include:

  • A commitment to the Paris Agreement and measures to implement it
  • Current ESG policy and evolution of this policy, for example land management and deforestation, but measures to reduce the carbon footprint
  • The share of renewable energies in a country’s energy mix
  • Its ranking on the corruption perception index.

Overall, our ESG assessment covers 89 factors.

How does our approach differ? Instead of inclusion or exclusion lists, we work with a composite score on each emerging country to determine the size of the investment we are including in our portfolios. We combine the opportunity to gain alpha on a country’s debt with its ESG rating, essentially increasing our overweightings in countries with a high ESG level. We still invest in low ESG countries where our belief that we can earn alpha is high, but we invest less in those countries than we would otherwise.

Exhibit 1: Case study – Uruguay and Angola

Beyond traditional sovereign and other quality issues and high yield bonds, we are also evaluating emerging market green bonds for inclusion in the portfolio. Here, the same standards apply as for green debt from developed markets: funds must be used appropriately, one must ensure that there is no green washing, the issuer must provide reporting transparent, etc. Investors should be careful: about half of EM green bonds are not green, while in developed markets, 80% actually are. Nonetheless, this is a promising area.

Investing in EMD: combining alpha potential and ESG ranking

By the way, we believe emerging debt portfolios need to be actively managed. Although there is more and more information about emerging markets and emerging economies, markets do not necessarily digest it effectively and still act quite often on the headlines (i.e. ‘noise’). ) and irrational concerns. At the same time, investors cannot trust rating agencies as they often act late. We believe it is best for investors to work with an experienced asset manager with a local presence and local knowledge regarding this complex asset class.

In summary, the combination of alpha potential and ESG ranking can produce an overall ESG oriented portfolio without limiting diversification or reducing the alpha set. Attribution analysis has shown that ESG tilt can drive additional portfolio performance. It is also aimed at investors wishing or needing to take ESG factors into account, for fiduciary, ethical or regulatory reasons for example, or investors with a strong focus on risk mitigation, including reputational risk. Like many investors, we are committed to the viability and long-term performance of investments, hence our view that ESG investing needs to be widely adopted.


This article appeared in The Intelligence Report – October 29, 2019


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All opinions expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different opinions and make different investment decisions for different clients.

The value of investments and the income from them may go down as well as up and investors may not get their original stake back.

Investment in emerging markets, or in specialized or small sectors is likely to be subject to above-average volatility due to a high degree of concentration, greater uncertainty because less information is available. available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of developed international markets. For this reason, portfolio transaction, liquidation and custody services on behalf of funds invested in emerging markets may involve higher risk.



Carol M. Barragan

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