Investors that picked emerging market stocks based on their environmental, social and governmental rating potentially outperformed those that ignored them, according to a new report by Cambridge Associates.
The global investment firm’s three-year analysis of both the MSCI Emerging Markets ESG Index and its parent index, the MSCI Emerging Markets Index, found the former outperformed the latter by a cumulative 12 per cent on a total return basis, and that more than 50 per cent of that performance can be attributed to environmental, social and governance factors alone.
“Using these criteria to help pick stocks in emerging markets really helps to separate the wheat from the chaff,” says Chris Varco, senior investment director for mission-related investing at Cambridge Associates.
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“Of the 367 basis points of annualized outperformance achieved by the MSCI Emerging Markets ESG Index, some 199 basis points were attributable to ESG factors after we accounted for the contribution of other factors such as country, currency, sector and style.”
Investments in the ESG index consider: environmental factors such as carbon emissions, toxic waste and opportunities in green buildings and renewable energy; social factors such as health and safety for employees, product safety and quality, controversial sourcing and opportunities on access to finance; and governance factors such as business ethics and anti-competitive practices.
Varco noted that the study dispelled the notion that ESG factors are merely proxies for other valuable investment tools and confirmed their credence in the markets.
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“When making investment decisions, investors in emerging markets equities often focus on commodity prices, currency, and macroeconomic factors, as well as domestic consumption trends, and they tend to underestimate the value of this widely available information on the ESG strength of companies in emerging markets,” he said.
Varco attributed the success of the ESG emerging market index to its avoidance of state-owned enterprises. While there were 13 such enterprises among the 40 largest companies in the parent emerging market index during the last three years, the ESG index had a zero weighting in 11 of them.
“[State-owned enterprises] are influenced by interests beyond generating profits for shareholders, which can negatively impact operational aspects of the business,” said Varco. “The same accusation has been made for some family-owned businesses, which are also common in emerging markets.”
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