At Kames our approach to emerging market debt shares some of the underpinnings of ESG investing. Moreover, this focus has always been integral to investing in emerging markets, long before its strands became as widespread as they are today in developed markets investing. In emerging markets, numbers have always been only half the story. Below are some thoughts and examples of what else counts.
The most important ESG factor in emerging market debt is governance. At both the sovereign and corporate level, bad governance in emerging markets can impair an investment well beyond the level typically possible in developed markets. Simply enough, the backstop of the rule of law, relied upon by investors in developed markets, is much less tested in emerging geographies. This means that the quality of the people (whether government ministers or management teams) and organisations (Ministries of Finance, Central Banks, and the like) involved is vital.
A good example at the sovereign level are the two West African countries Senegal and Cote d’Ivoire. Both score well on the highly-regarded Ibrahim Index of African Governance. Both are members of WAEMU, the West African Economic and Monetary Union, with its emphasis on co-operation, stability, and its ties to France. In addition, Senegal arguably has a stronger democratic tradition than many of its regional peers. Such indicators of governance strength are critical pillars of the credit cases in these names.
On the negative side, our view of Russian private banks and corporates is consistently held back by the encroachments of the state on the business interests of independent actors there. Notwithstanding the fact that there are, and have been, some high quality, non-state owned banks and corporates in Russia, it is hard to see past the Russian government’s centralising instinct, and its controversial foreign policy decisions, which have rebounded heavily on the Russian economy in the form of sanctions. These factors act as a persistent drag on the investment case for Russian debt.
As emerging market debt is often driven by, or linked to, commodities – oil & gas, metals & mining, agricultural commodities, and the like – and as the production of these very often has a lasting impact on geographies and populations, the questions of environmental and social factors should not be ignored, either.
For example, investors in credits exposed to Nigerian oil and gas should be aware of the controversial history of foreign involvement in the Nigerian energy space. Whether it is the industry’s environmental impact, its record in employing locals, or the imperfect nature of contracts signed, the sector is steeped in environmental and social challenges that, from our perspective, significantly raise the bar for investment in it.
More constructively, it can be argued that a positive example of social change is currently to be seen in Saudi Arabia. Under the new Crown Prince, steps are being taken to ease restrictions on the country’s large young population. These include the easing of segregation between sexes, investment in entertainment venues and the marginalisation of the religious police. There is no doubt that Saudi Arabia faces multiple challenges of other sorts under Mohammad bin Salman – a still heavily oil-dependent economy, an aggressive foreign policy, among others – but the steps being taken undoubtedly strengthen the investment case for Saudi Arabia.
It is very important to stress that questions of governance, as well as social and environmental challenges, are far from black and white issues in emerging markets. Politics are imperfect; social norms vary widely; economies are resource heavy. Indeed, an attempt to enforce a ‘one size fits all’ approach to these matters in emerging markets would be both ill-informed, and a mistake. That said, at Kames we closely consider these factors when buying emerging market bonds. In emerging markets, numbers have always been only half the story.