IFC Advisory Services in Environmental and Social Sustainability Sustainable Investing in Emerging Markets: Unscathed by the Financial Crisis ISSUE BRIEF In partnership with Italy, Luxembourg, the Netherlands, and Norway Introduction To support the growth of sustainable capital flows, governance investment criteria; and recommends actions to IFC’s advisory services seek to influence, support, and capitalize on relevant trends. This report is based on: enable capital market stakeholders to better integrate environmental, social, and governance (ESG) factors into • Two surveys, conducted two years apart (early 2007 capital allocation and portfolio management processes, and early 2009), addressing the same audience of: using IFC’s own investment practices as a model. IFC is –– public companies based in emerging markets playing its part to support the growth of the market –– asset owners and asset managers with significant by funding the development of enhanced stock market investments in emerging markets indices, financial instruments, and through targeted market research. • In-depth interviews with 23 emerging market investors, investment consultants, ratings agencies, Sustainable Investing in Emerging Markets: Unscathed and academics, as well as post-crash follow-up by the Financial Crisis is a research paper commissioned interviews with selected interviewees. by IFC, and prepared in cooperation with the Economist Intelligence Unit (EIU). It provides a unique “before • Comments from investors, advisors, and emerging and after” snapshot of mainstream investor opinion on market corporations at roundtables in Buenos Aires, sustainability issues in emerging market equity investment, Hong Kong, London, and New York. comparing pre-crisis (2007) to mid-crisis (2009). The report surveys the attitudes of corporate executives and investment The report can be downloaded in full from IFC’s website; professionals; summarizes the challenges that they face in this summary version highlights the major findings of adapting to the growing use of environmental, social, and the surveys. EXECUTIVE SUMMARY How will the financial crisis affect the integration of ESG factors into traditional investment practices? Over a century ago Rudyard Kipling told his countrymen, “If you can keep your wits about you while all others are losing theirs…the world will be yours and everything in it.” For in- It will result in more use of vestors caught in the market turmoil of 2008 and 2009, these ESG criteria words have special resonance. Years of short-term thinking by It will result in less use of ESG a wide range of market participants culminated in a global fi- criteria in the short term and the long term nancial crash. Leading the way out will be those who “keep their wits about them” by focusing single-mindedly on choos- It will result in less use of ESG ing emerging market investments with advantages that can criteria in the short term, but not in the long term be sustained over the long term. Such an approach almost by definition requires the use of ESG measurements as an aid to It will have no effect evaluate an investment’s fundamental strength. 0% 10% 20% 30% 40% 50% 60% In tumultuous times, the behavior of market participants changes. They become less rational. They make bad decisions. Asset owners Fund managers Emerging market companies They miss opportunities. Most importantly, they lose sight of fundamentals, act on the basis of short-term events, and fall prey to the “madness of crowds.” It seems reasonable that investors in this frame of mind would be ready to abandon the use of indices move toward record highs; and the second in March sustainable criteria and revert to a narrower set of short-term 2009, when the same indices were in free fall. In both surveys, metrics for evaluating investments. But the asset management market participants confirmed the importance of sustainability community is not abandoning ESG criteria; far from it. Two criteria in analyzing emerging market investments. If anything, surveys of asset owners, fund managers, and emerging market respondents were more enthusiastic about sustainability corporate issuers were conducted by the EIU for this project: criteria after the crash than before. For instance, asset owners the first in March 2007, when market participants watched (arguably the most influential participants in the investment 2 Sustainable Investing in Emerging Markets: Unscathed by the Financial Crisis value chain) were more inclined to agree with the statement Asset Owners: “ESG issues are an important part of our research, portfolio What is your organization’s motivation for management, and manager selection process” in 2009 than addressing ESG issues? (choose up to two) in 2007. Approximately 46 percent strongly agreed with this statement in 2009, up from 36 percent in 2007. Those who agreed “somewhat” were the same at about 35–36 percent. Investment or business merit In 2009, a plurality of asset owners (42 percent) said that the Regulatory and compliance issues financial crisis would result in more use of ESG criteria than Your organisation’s before and 13 percent said it would have no effect. Another 35 own ethical guide lines percent said that the crisis might have the effect of reducing Customer demand the use of sustainability criteria in the short run, but not in the long run. Only 1 in 10 respondents felt that the financial crisis Media attention would reduce the focus among investors on ESG. Pressure from NGOs Other major findings presented in the report: 0% 10% 20% 30% 40% 50% 60% •• Asset owners ranked “investment or business merit” far Q1 2009 Q1 2007 ahead of other motives for sustainable investing in 2009, suggesting that sustainable investing criteria are less a mat- ter of fulfilling compliance mandates than an aid to choos- ing strong investments. In the 2007 survey, asset owners Asset Owners and Asset Managers: ranked “regulatory and compliance considerations” slightly Over what time horizon will climate change have ahead of other motives. a significant impact on your emerging market investment porftolio? •• The ranking of obstacles to sustainable investing did not change much between the sunny days of 2007 and the 40% bleaker ones of 2009, but significantly fewer asset owners ranked transparency as one of the top obstacles in 2009. 30% •• The 2009 survey reinforced the need to take climate change into account when evaluating investments. Most 20% asset owners and funds managers (86 percent of both groups) believe that it will have a significant effect on their emerging markets portfolios. Moreover, 60 percent of asset owners and 10% 62 percent of money managers say that this effect will be felt within the next five years. 0% 3 years 5 years 10 years 20 years More than No effect •• In both surveys, asset owners and fund managers noted the or less 20 years growing importance of ESG criteria in emerging markets; they also expect increased demand for emerging market in- Asset managers Fund owners vestment products over the next three years. Among publicly traded companies headquartered in emerging markets, there is also a high level of awareness of sustainable criteria. Sustainable Investing in Emerging Markets: Unscathed by the Financial Crisis 3 Asset Owners: Asset Managers: What is needed to improve the climate for ESG What is needed to improve the climate for ESG investing in emerging markets? (select all that apply) investment in emerging markets? (select all that apply) Better ESG reporting and Better ESG reporting and disclosure by companies disclosure by companies Better evidence for the Better evidence for the business/investment case business/investment case More ESG training for Clarity on consistency of ESG investment professionals strategies with fiduciary responsibility More government guidance and regulation More government guidance and regulation Appropriate benchmark indices More ESG training for investment professionals Clarity on consistency of ESG strategies with fiduciary responsibility Better sell-side research Better sell-side research 0% 10% 20% 30% 40% 50% 60% Appropriate benchmark indices 0% 10% 20% 30% 40% 50% 60% Q1 2009 Q1 2007 Q1 2009 Q1 2007 In sum, the investment community continues to see the use The full annual report gives a detailed analysis of mainstream of sustainable investment criteria in emerging markets as both investor opinion on sustainability issues in emerging market mainstream and persistent, even after the value of their portfolios equity investments, highlighting the business case for ESG, as has shrunk; and emerging market corporate issuers continue to well as identifying the challenges and opportunities that lie see sustainable practices as important for fund raising. Investors ahead. who neglect these sustainability criteria run the risk of missing opportunities to make a profit, while companies that fail to build sustainable operations may end up paying too much for capital. Sustainable investing in emerging markets: Unscathed by the financial crisis, full report: http://www.ifc.org/sustainableinvesting Written by and interviews carried out by John Christy and Dan Armstrong, EIU Editorial team: Cecilia Bjerborn, Berit Lindholdt Lauridsen, and Maria Delores Hermosillo Photo Credit: Ray Witlin, World Bank Special thanks to those who took part in the surveys as well as the donor governments of Italy, Luxembourg, the Netherlands, and Norway. The findings, interpretations, and conclusions expressed in this publication should not be attributed in any manner to IFC, to its affiliated organizations, or to members of its board of Executive Directors or the countries they represent. 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