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Emerging Markets
Emerging Markets – monthly
June 2021
The Growth School of ESG: How spotting ESG It turns out there are a whole host of benefits from bringing
improvers can help returns and society a growth mindset to ESG.
Growth investing comes in many flavours but, at its heart, is a First, it is good for returns. ESG funds have seen cumulative
focus on potential. Instead of fixating on the past, or even the inflows of about $300bn since 2015 but most of the money
present, we imagine what a company can become. The focus is chasing ESG leaders. That space is getting crowded.
is on upside and opportunity as we try to identify the leaders
of tomorrow instead of simply crowning today’s winners. The real opportunity lies in finding companies that can grow
their ESG profile. A 2015 MSCI study found that ESG
The Environmental, Social and Governance (or ESG) improvers beat ESG leaders by 1.1 per cent on an annualised
investing of today is diametrically different. There is a fixation basis and outpaced the MSCI World Index by 2.2 per cent.
on the past and sussing out ESG flaws that risk returns. The Subsequent studies by AllianceBernstein and Rockefeller
guiding question is: What can go wrong? Once the boxes are Capital Management have also found that focusing on ESG
ticked and the forms are filled, there is then a rush to crown improvers can really pay off.
companies that have already arrived. Potential, opportunity,
growth. They are nowhere to be found. Growth ESG is also good for society. Celebrating ESG
leaders is less useful than nudging along the firms that are
So, what would Growth ESG investing look like? Instead of early in their ESG journeys. As active investors we have the
piling into the winners, it would focus on the ESG laggards power to shape outcomes, instead of just tracking them.
with the potential to grow into champions. And to differentiate
the stubbornly bad from the potentially good, it would rely on This change in mindset is particularly important emerging
bottom up analysis to find hints of future change, instead of markets (EM), where there are more ESG laggards than in
peddling summary statistics of historical data. developed regions. The existing ESG model shunned EM,
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This update is solely for the use of professional investors and should not be relied upon by any other person.
It is not intended for use by retail clients.
Emerging Markets
even though it needs the most capital. The images of broken I bring this up because if you define the metrics narrowly,
healthcare systems that we saw during Covid should remind they become easy to game. So, imagine an apparel maker
us how far capital can go there and how wrong it would be to that operates in Bangladesh where worker rights are a
pull out simply because we cannot tick a box. challenge. To ‘grow’ its ESG score the firm then moves the
work to a highly automated plant in, say, Mexico. The risk
With Growth ESG, the glass is suddenly half-full. The same
from labour issues dwindle and so the ESG score goes up.
potential for convergence that drives broader EM investing
exists in the ESG space too. Adopting this approach would But I invite you to explain how this is progress to the children
allow capital to flow to areas that need it the most and who are pulled out of school in Dhaka and Chittagong
where returns on capital can be higher. because their mothers’ factory has been shuttered. The right
thing to do would have been to engage with the company to
Picking potential improvers in the large pool of ESG
improve standards within a Bangladeshi context. That is
offenders is hard work. It can’t be done by dredging
Actual Growth ESG.
summary statistics. Every company now knows it has to talk
the ESG talk, so it takes bottom up fundamental research sift So, both the mindset and metrics of ESG investing need to
progress from platitudes. Investors are used to judging the change if it is to generate sustainable returns and be a force
sincerity of commitments about investing for growth or for good. As the importance of ESG grows we have to debate
eschewing mergers and acquisitions so we might have an carefully what it really means. Otherwise, there is a danger
edge here too. that the industry will coalesce around what is easy, instead of
what is right.
Changing our mindset from the old ESG of crowing
champions to the Growth ESG of picking and prodding
improvers unlocks tremendous social and financial value.
But, it is only half the battle.
The metrics used for ESG investing are also broken. This is
especially true when it comes to measuring the ‘S’ in ESG.
ESG analysts have chosen narrow metrics like fair pay,
human capital management and data security as proxies
for ‘Social’ because they are easy to measure. But this
misses the point. What really matters is whether companies
leave societies better off.
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