ESG factors drive stronger performance in emerging markets equities

By Roger Aitken— Investing in emerging markets (EM) equities with high environmental, social and governance (ESG) ratings leads to “better performance” when adjusted for country and sector factors, according to analysis from Dutch-headquartered asset manager NN Investment Partners (NN IP). And companies with a high ESG rating were found to have delivered “higher Sharpe ratio”.

Titled ‘The Materiality of ESG factors for emerging markets equity investment decisions: academic evidence’, and conducted in association with the European Centre for Corporate Engagement (ECCE) at Maastricht University’s School of Business and Economics, the report claims to be the “first comprehensive investigation” into the performance of EM equity portfolios using ESG criteria.

The findings, which tracked data between early 2010 and late 2015, were based on 650 companies in the EM universe in June 2012 and expanded to 751 companies by June 2015, found that gains from investing in companies with higher ESG ratings are stronger in EMs than in developed markets (DMs), while ownership structures of companies were the “most important corporate governance driver”.

The seven-page report also revealed that EM companies with a high ESG rating outperform those with a low rating on a risk-adjusted basis, and “excluding companies with controversial ESG behaviour” adds to overall performance.

Jeroen Bos, Head of Equity Specialties at NN IP, (pictured) said: “This new report confirms a number of important findings from our prior report on ESG factors in DM equities.

“We have now found a clear and positive relationship between incremental changes – or momentum – in a company’s ESG scores and investment performance in both developed and emerging markets.”

He added: “Excluding companies with controversial ESG behaviour also resulted in an uplift in the Sharpe ratio, similar to our experience in Developed Markets. The implication for investors is to consider both level and changes in ESG scores when constructing an emerging markets equity portfolio, as both factors contributed to risk-adjusted outperformance.”

The report contends that portfolios “should be adjusted” to take account of the fact that countries and sectors have a wide variety of ESG ratings stemming from different cultures, regulatory regimes, ownership structures and business practices.

Based on the analysis. an unadjusted portfolio of high ESG-rated stocks would have a large overweight to certain countries or sectors – skewing the performance.

Nathan Griffiths, Senior Portfolio Manager in NN IP’s Emerging Markets Equity Boutique, added: “It is important to understand how the performance of EM equities is affected by these ESG factors because there is growing demand among ESG investors for a broader choice of assets.”

He added: “Furthermore, the ESG challenges at play in EMs can be very different to those in DMs. But in general, if a company makes a meaningful effort to improve its ESG policies then it can, on average, expect better relative share price performance.”

EM companies are often assumed to give little or no consideration to the sort of sustainable practices that are increasingly considered an essential requirement for companies in developed markets. However, NN IP noted that the asset management industry has a “role to play in holding EM companies to account on ESG factors”, which will play an increasingly important role in investment decisions.

The latest study sourced data from Datastream, ECCE, Sustainalytics, MSCI ESG and NN IP research.