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By Nish Popat
Investing sustainably in emerging market corporates could be important to a the planet, and to finding fixed income growth opportunities.
COP27, the 27th U.N. Climate Change Conference of the Parties to the Paris Agreement on climate, is underway in Egypt.
The location has put a spotlight on the emerging world’s particular vulnerability to climate change, and on the idea of a “just transition” away from fossil fuels.
The OECD estimates that there could be a $4.2 trillion shortfall in annual funds needed to meet the U.N. Sustainable Development Goals (SDGs) in developing countries by 2030. Although that’s a significant number, it would require only 1.1% of $379 trillion in overall global financings to close the gap.
As investors in emerging markets (EM), we believe Neuberger Berman and our clients play a crucial role in directing some of that capital to companies that are looking to adapt to the changing climate of sustainable development.
Sustainable development doesn’t happen passively, however, and investing passively is unlikely to generate exposure to the benefits of sustainable development. To do that, we believe sustainability analysis and ESG factors should be integrated into investment processes, involving active decisions that target sustainability.
We see two key benefits to sustainable development exposure. One is risk mitigation: Fossil-fuel-intense sectors make up 25% of EM corporates and include direct and indirect exposure to coal – a fuel that is likely to be phased out over time, presenting a risk of “stranded assets.” Another is potential exposure to companies that are growing because they contribute to SDGs, such as those involved in renewable energy.
In our view, EM corporate portfolios should have higher targeted ESG scores than the benchmark, threshold allocations to sustainable investments, net-zero greenhouse gas emissions targets and short-term targets for reducing carbon intensity.
At the company level, we favor integrating environmental, social and governance factors into security analysis, businesses that meet the Sustainable Finance Disclosure Regulation definition of “sustainable,” and engaging in active engagement on sustainability issues.
This is ambitious, considering key challenges including lack of disclosure and data. But we believe focus and engagement on these issues can drive change, and that, ultimately, the “direction of travel” is unavoidable if we are to achieve both sustainable development and attractive returns.
In our view, companies that effectively transition to become more sustainable are more likely to see lower reputational risk and greater support from bond holders, potentially leading to cheaper financing in the markets.
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