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‘We seek similar returns, but with a better sustainability profile’

‘We seek similar returns, but with a better sustainability profile’

25-09-2019 | Insight

Sustainable investing in emerging markets is gaining momentum. Previously pursued mostly in developed markets, it has become a growing theme in developing economies as well, particularly Asia. The launch of its new Sustainable Emerging Stars Equities fund enables Robeco to build on the success of an existing portfolio, using enhanced ESG screening in order to give it a pronounced sustainability profile. Portfolio manager Jaap van der Hart discusses the reasoning behind the decision to launch the fund.

  • Anastasia Gnezditskaia
    Anastasia
    Gnezditskaia
    Investment writer

What was the motivation behind the launch of the fund?

“There is a growing demand for sustainable funds, particularly among clients in the Benelux and Nordics, but also elsewhere. ESG integration has become an increasingly important element in our investment process over the past 15 years, so this is something that comes natural to us. We can build on the successful track record of our Emerging Stars Equities strategy, as well as our ESG experience within the team and Robeco.”

“This is the third sustainability focused fund for Robeco fundamental equities, following Sustainable European Stars Equities and Sustainable Global Stars Equities.”

“The aim is to create a sustainable fund but with the same objective of generating superior risk-adjusted returns for our clients. We follow the same investment process and style, and more than 70% of the holdings are in both funds.”

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How do you define sustainability?

“The sustainability criteria for the fund include a wider exclusion list compared to mainstream funds, encompassing amongst others exposure to thermal coal and military equipment. Also, the new fund excludes the 20% worst-scoring companies in emerging markets based on RobecoSAM’s Smart ESG Score. And we only select companies that comply with the criteria for sustainable funds for the Belgian financial market (Febelfin).”

“There are also restrictions for the overall exposure at the portfolio level. The fund must have a better Smart ESG Score than the MSCI Emerging Markets Index and a 20% lower environmental impact score, based on four dimensions: greenhouse gasses, energy, water consumption and waste. These are just the minimum requirements, in practice the portfolio significantly exceeds these limits.”

“Last but not least, we are looking beyond these quantitative criteria by also incorporating our fundamental knowledge of companies that we can invest in. We are aiming to select companies that do well on many dimensions of sustainability.”

How do your inclusion criteria differ from those of the main Emerging Stars fund?

“The first difference is that there are several Emerging Stars holdings that do not pass the higher threshold required to make it into the new Sustainable Emerging Stars portfolio. The new fund excludes the bottom 20% based on a Smart ESG Score and the Febelfin criteria. As a result, it excludes upstream oil and gas companies that are not participating in the energy transition.” 

“In addition, we do not invest in two companies that are technically a good fit but still have a low ESG score and high environmental impact. All in all, holdings in the Emerging Stars fund make up more than 70% of the Sustainable Emerging Stars fund. The remaining 25 to 30% are more sustainable companies that also offer attractive returns. For the large part, they come from countries and sectors that we already invest in as a part of the existing Emerging Stars fund. And, we have found a few additional interesting investment opportunities.”

So, what sort of themes or places do you invest in?

“Several areas are given more weight in the Sustainable Stars fund. For example, we invest more in Taiwan, and specifically in the IT sector, which scores well on our ESG goals and is also attractive financially. Also, we have a higher weight in Brazilian utilities, where most energy is mostly produced by hydropower, in Indian IT outsourcing companies and in the Chinese healthcare sector. In addition, we were able to find several companies that are playing an important role in the transition to a cleaner world and are attractive from a financial point of view.”

How do you get the sustainability data that you need – isn’t it unreliable in emerging markets?

“Our primary data sources are RobecoSAM’s Country Sustainability Ranking (top-down analysis) and the Corporate Sustainability Assessment and ESG Dashboard (bottom-up research). These are complemented by various external sources of information from data service providers such as Sustainalytics, Glass Lewis, ICRG and Transparency International.” 

“I would not say the data is unreliable. A number of companies produce extensive corporate sustainability reports and, for those that don’t, there are external sources of information. And if there is insufficient evidence that companies comply with good practices, we simply do not include them in our portfolio. In the end, it is about how you deal with the information available in your investment process. Still, there is considerable room for improvement in emerging markets. Many companies still don’t generate CSR reports or their reporting can be significantly improved. This is something that we also address when speaking to the management of these companies.” 

“We have also observed differences between countries in terms of the information they provide. In general, there are quite a few Chinese companies where reporting could improve, while Thailand, for example, really stands out as being very good in reporting.”

Does ESG have the same meaning in emerging markets as it does in developed ones?

“It means the same thing. The principal difference is that sustainability profiles vary more in emerging markets. The best emerging companies are on a par with the best developed companies, yet at the same time you will find more companies with mediocre profiles. From that perspective, sustainable investing is even more relevant in emerging markets.”

How does this SI focus manifest itself within countries, sectors or themes?

“To a large extent, the Sustainable Emerging Stars fund has similar country positions as Emerging Stars. Yet, there are a few differences. First of all, it does not hold Russian oil and gas companies, and there aren’t that many good alternatives in Russia that score well for expected returns and sustainability. The fund therefore has a lower weight in Russia. By contrast, Thailand stands out for the quality of reporting and sustainability and, therefore, is given more weight in Sustainable Stars. Taiwan also scores well, especially in the technology sector, and is also given a higher weight.”

“In terms of sectors, the Sustainable Stars fund has less exposure to energy and materials, two sectors that have a higher share of polluting companies. More weight is given to the technology sector, which includes Taiwanese hardware companies, Indian IT outsourcing companies and a Korean battery maker. Also, Brazilian utilities companies that rely on hydropower and Chinese healthcare company are given more weight.”

 “The result is an actively managed portfolio with about 40 to 50 stocks, just like for Emerging Stars. As to be expected, Sustainable Emerging Stars has a clear sustainability profile, with significantly higher ESG scores, a lower environmental impact and the exclusion of poorly scoring companies. Aside from the ESG angle, it remains important to find those companies that are reasonably valued, and have an underappreciated earnings outlook that provides upside for the share price.” 

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