Socially responsible investment (SRSI) forms a small but influential, $2.7trn (E2.2trn) industry comprised of nearly 800 retail funds and many more institutional investors. As an investment strategy, it focuses on the vital links between financial return, global economic growth and sustainable development. In theory (and depending on motivation and approach) it delivers results that correspond to investors’ ethical values without compromising return on investment; in many cases it is predicated on an ability to generate lower volatility, positive returns by using non-quantitative analysis and shareholder engagement to focus capital on companies who understand how critical environmental and social performance is to their sustained commercial success. And ‘SRSI’ insight and techniques are increasingly being adopted by the ‘mainstream’, as Goldman Sach’s recent sell-side research on sustainability issues in the energy sector attests.
Whether the prize is social responsibility or out-performance, the emerging markets offer potentially fertile territory. Developing countries offer many of the world’s most precious natural resources; lower labour costs; innovative and ‘can do’ business cultures; and industrial assets that have substantial scope for creating shareholder value through privatisation or the adoption of modern technology and management approaches. The development of their domestic markets is crucial to sustained global economic growth and the retirement prospects of millions of North American and western European baby boomers. On the other hand, developing countries also face some of the world’s most fundamental environmental and social challenges. Weak frameworks for formal regulation and civil society engagement mean that the private sector has a much greater role to play in solving these problems than in the west. At the same time, these factors mean that the ‘bottom line’ business case for social and environmental excellence is often more direct and much less marginal for emerging market companies.
On the face of it, an ethical investor could do much more ‘good’ dollar-for-dollar by investing in and engaging with a company listed on say, Brazil’s Bovespa than in the usual universe of western stocks. Return-oriented investors could, potentially, make shrewder use of the SRSI advantage by identifying undervalued emerging market stocks and helping those companies to exploit their sustainable business potential. If, as many observers accept, there is typically an inverse correlation between developed and emerging capital market performance, greater exposure to the latter could provide portfolio diversification advantages for European investors.
Yet a recent study commissioned by the International Finance Corporation (IFC), the private sector arm of the World Bank Group, indicates that only around $2.7bn – or less than 0.1% – of global SRSI assets are invested in emerging market securities, and nearly half of this comes from domestic investors in developing countries. The study, Towards Sustainable and Responsible Investment in Emerging Markets, was prepared by the Mexico-based Enterprising Solutions consultancy. It finds that SRSI investment within emerging markets differs widely, with South Africa garnering the lion’s share at $230m or 70%. Most of the rest goes to Asia, particularly South Korea. Latin America and Africa receive little SRSI investment.
Enterprising Solutions concludes that a key barrier to large-scale global SRSI investment, appears to be the absence of a supporting infrastructure. In the developed world, there are a variety of ways to access SRSI information and check its validity. There is also a host of supporting organisations such as UK SIF and its counterparts in the US, Canada and continental Europe. Only Asia has a similar support network in the pioneering form of the much-respected Association for Sustainable & Responsible Investment in Asia (ASrIA). Access to high-quality SRSI information on companies in emerging markets is also patchy: the only index currently in existence is the Johannesburg Stock Exchange Sustainability Index (a joint venture with FTSE4Good), although plans are also afoot for a sustainability index on the Brazilian stock exchange, Bovespa. Credible ‘local’ research houses such as South Africa’s SR&I are few and far between and although western analysts/advisors such as KLD, SAM, Innovest and EIRIS have undertaken some ‘one-off’ research or have expressed interest in expanding into emerging markets, limited market demand means it may be some time before the commercial case is strong enough for them to make this leap. Methodology also presents a key challenge: the SRSI criteria and standards that are material to a UK-based investee company are unlikely to be directly transferable to China, for example, and the questionnaire-based research model used by many western SRSI analysts is unlikely to be robust enough or culturally appropriate.
This information deficit is coupled with a host of biases. Emerging markets are associated with corruption, a lack of transparency, ineffective laws, illiquid stock markets and general political risk. As a result, it is difficult for retail funds in the industrialised world to develop viable products, and many investors in the developing world still find the concept of SRSI (and stock market investment) as alien.
Nevertheless, there is a growing body of evidence to suggest that corporate social responsibility adds financial value to businesses in emerging markets. For example, Developing Value, a report published in 2002 by UK-based consultancy SustainAbility in association with IFC and Brazil’s Ethos Institute, surveyed 240 businesses in more than 60 countries to compile a wealth of case studies on companies that gained measurable shareholder value through the strategic use of social and environmental performance improvement measures.
Influential programmes such as the Just Pensions project and shareholder initiatives such as ‘Pharma Futures’ and, more recently, the ISIS-led ‘Investors Statement on Transparency in the Extractives Sector’ reflect a growing appetite at the cutting edge of the SRSI movement to engage in the international development agenda, and there is increasing background “chatter” about new possibilities in the emerging markets.
At the same time, multilateral institutions such as the World Bank and IFC and public-private partnerships such as the UN Environment Program Finance Initiative and the Global Compact are also turning their attention to this topic. The environmental and social policies and procedures followed by organisations such as IFC, EBRD et al have close parallels with ‘SRSI’ analysis, and have long been applied to the multilaterals’ direct financing of private sector projects in emerging markets and to their large portfolios of investments in developing country private equity funds, commercial banks and microfinance institutions. IFC and its clients now increasingly recognise and focus on the added-value benefits of environmental and social sustainability in the investment relationship.
With their emphasis on projects that directly support economic, environmental and social development, multilaterals have historically not focused on public listed equity investment, SRSI or otherwise, and must approach the concept with understandable care. For its part, IFC is continuing its process of informal dialogue with the SRSI and mainstream investment communities in both the developed world and the emerging markets and has a number of technical assistance projects in development to follow the Enterprising Solutions’ study. IFC is scoping out whether and how it can play a facilitating role in emerging market SRSI: however, success will clearly depend on many actors and fundamentally, institutional investors and pension fund trustees will determine whether SRSI and emerging market investment is a viable marriage.
Dan Siddy is a specialist in IFC’s Sustainable Financial Markets Facility in Washington DC