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Robeco has been incorporating sustainability in the analysis of emerging markets companies for over 15 years. What started as a corporate governance survey in 2001 evolved into an Environmental, Social, and Governance (ESG) survey in 2014. In this year’s survey, South Africa continues to be in the lead, while India and Mexico are the biggest risers.
These considerations become even more relevant as emerging markets companies are adopting developed market standards to expand the global market share of their goods and services, and tap into new capital markets.
To us, this makes intuitive sense. When there are fewer external institutions to protect minority shareholder interests, good governance becomes more important. Dealing with pollution has become a priority for governments in emerging markets, creating both opportunities and challenges for companies there. Social issues, such as income disparity and the risk of social unrest, are equally crucial as illustrated by several high profile cases of protests and labor strikes in recent years.
Empirical evidence supports our belief that there is a positive relationship between ESG criteria and financial performance. In a 2015 study, Friede, Busch and Bassen collected evidence from more than 2,000 studies to search for such a relation. Their findings suggest that ESG outperformance opportunities exist, particularly in emerging markets.
Our ESG analysis is part of the bottom-up investment process, which seeks to select attractively valued stocks with a high return potential. We believe that a by-the-numbers approach, without reference to quality indicators and the structural long-term sustainability of business models risks ignoring intangible factors which increasingly explain companies’ market value. Our survey aims to capture some of these intangible factors, which are listed below:
The table below shows the changes since the previous ESG survey came out in 2014.
While our data collection and analysis are done at the individual company level, we have aggregated the 865 ESG scores here to provide a snapshot of the results at a country level. This gives an indication of the markets where, within our core universe, more sustainable companies are clustered.
As in our 2014 survey, South African companies (ZAF, Figure 1) continue to lead, doing particularly well in the area of Board and Management. This is unsurprising given that South Africa has adopted the King Corporate Governance Code, which is considered a global leader that has set the standard in terms of governance and sustainability.
The biggest risers since the previous survey are India (IND) and Mexico (MEX), which have seen improvements in Management Discipline and Social Performance, respectively. At the bottom of the table countries such as Egypt (EGY), Indonesia (IDN) and China continue to perform poorly.
While the aggregated results at a country level offer interesting insights, they do not tell the whole story. It is important to look at the results across different categories to form a more complete and balanced view of sustainability factors within countries. For example, Figure 2 breaks down the performance of South African companies into the different categories of the survey. The chart shows that South African corporates perform above average in most categories but many underperform in the critical category of Financial Risk. The survey’s identification of such red flags tempers our conviction on the sustainability of South African companies.
Drilling down deeper, it is the company-specific analysis that offers the most relevant contribution to our investment process. Figure 3 shows an example of our ESG Survey’s output for an Indian company, which we will call XYZ. In company XYZ’s case, the Board & Management category scores particularly poorly, which is a reflection of a number of issues with their board structure. Our chart also indicates that there may be opportunities for XYZ to improve its environmental performance. Our more detailed survey output also highlights a number of red flags which need to be explicitly addressed to form a comprehensive investment case.
These red flags also feed into Robeco’s approach to company engagement. We select a number of companies where we believe we can contribute to the improvement of their ESG profile and engage with company management. These initiatives have shown positive results over the years and companies have been showing an increasingly positive reaction to our engagement efforts.
The input from the ESG survey is combined with other resources that are available within Robeco. For in-depth analysis we make use of RobecoSAM’s Corporate Sustainability Assessment. For country allocation, a country sustainability ranking is calculated using the knowledge of Robeco’s Fixed Income Investments department and RobecoSAM.
Integrating ESG factors into our investment process does not mean that we invest in companies because they have perfect ESG scores. Rather, we take ESG factors into account by integrating these into our investment cases and valuation models. In some cases we may come to the conclusion that a company is attractively valued despite its ESG challenges. This is also where we find an opportunity to engage with companies. We therefore see the integration of ESG analysis and engagement into our investment process as an important contributor to performance.