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TrackInsight: ESG investing in Emerging Markets

03/30/2021 | 09:28am EDT

Investors in Emerging Markets face more challenges and have a harder time selecting ESG-friendly companies.

Sustainable and ESG investing took the center stage over the past decade but ESG awareness remains uneven around the globe. Developed markets offer better access to ESG data, with more companies reporting and a higher degree of disclosure. Companies in developed markets are also shifting their practices faster to meet ESG standards (such as United Nations’ Sustainable Development Goals).

By contrast, investors in Emerging Markets face more challenges with ESG investing. Those investors have a harder time selecting ESG-friendly companies. It goes beyond having lesser standards for ESG reporting. Emerging Markets such as Mexico also have a higher proportion of lower ESG-rated companies. This does not leave as many companies for investors to put into ESG strategies. As a result, Emerging Markets ESG ETFs tend to have lower ESG ratings and higher exposures to controversial themes.

Higher exposures to controversial themes

At TrackInsight we measure the ESG-ness of ETFs by looking at their underlying holdings. We retrieve the consensus-based ESG rating (via Conser) for each security and measure the strength of the consensus. Consensus means that the sources agree on the ESG rating of companies. We find that there is usually a higher level of consensus in funds which hold developed market securities than with those holding emerging market securities.

As illustrated below, our data shows that ESG ETFs offering exposure to Emerging Market equities have a higher risk of being flagged as having exposure to environmental, political and social issues such as Oppressive Regimes, Corruption or Cluster Bombs.

ESG Investing. How frequently are ESG ETFs flagged with exposures to the following controversies? Oppressive Regime, Human Rights, Corruption, Environment, Alcohol, Cluster Bombs, Weapons, GMO and Nuclear. A comparison between Developed and emerging markets.

Source: TrackInsight, averages based on 135 and 20 ESG ETFs from developed and emerging markets respectively, data as of 31st Dec. 2020.

The case of Mexico and China

Among the few D-rated ESG ETFs – the poorest rating in our methodology – we find ETFs investing in Mexican or Chinese stocks.

ESG Investing in Mexico

ETFs tracking Mexico indices have few constituents (less than 30). This leaves little room to apply sustainable strategies. Changes in the weighting scheme or excluding securities altogether could mean increasing company-specific risk beyond acceptable levels. Mexico’s economy is strong in controversial sectors such as fossil energies and alcoholic beverages which also involves background obstacles for implementing ESG strategies in the country.

ESG Investing in China

China does not face the same structural issues as Mexico. The challenge arises from weak consensus on the positive or negative ESG rating of individual companies. China’s lag in mandating ESG disclosures is likely to be a cause of the weak consensus rather than companies failing to implement ESG-friendly practices. This might be changing rapidly as Chinese regulators are setting goals for mandatory disclosures for listed companies with deadlines as short as 2021.

ESG Investing. ESG Consensus, China vs. Developed Markets
Source: TrackInsight, Conser average consensus based on 13 China ETFs and 135 dev. Markets ETFs, data as of 31st Dec. 2020.

We note that there are some ETFs with similar exposures and no sustainability considerations but higher ESG scores. Still, they do not rate significantly higher and fall in the lower end of the spectrum with ESG scores of C and lower.

ESG investing falls short in Emerging Markets

The challenges we highlighted go beyond Mexico and China. Emerging markets companies are still often lagging their developed counterparts in the movement towards more sustainable and ethical practices. The demand for ESG investment products is growing at a faster pace than companies can shift their practices. One can wonder if some countries are doomed to remain industry laggards at least in the foreseeable future.

Check out over 500 ESG ETFs scores on our ESG Observatory.


© www.trackinsight.com 2021
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