How would you define socially responsible investment (SRI)?
I actually prefer to talk about sustainable investment because I think the market has moved beyond the strict confines of "socially responsible investing" which is linked with ethical investing and negative screening of companies that don't meet ethical criteria. Sustainable investment, however, is much broader, more aligned with mainstream financial considerations and is where I think the market needs to be and has been moving towards in the last few years. This is more about long term financial security of a business which is only possible if the company manages itself in a sustainable manner. This means that companies and investors need to think about issues that may not have been considered financially material traditionally or in a very short-termist approach such as environmental, social and governance (ESG) factors. What we have seen over recent years though is that these "ESG" factors can be financially material and therefore should be considered as part of good financial analysis. For example, BP had a long history of accidents and bad environmental governance. Analysts that had taken notice of this may have recognized that there was a chance of a catastrophic accident, as we saw, and the financial repercussions of this for BP and its shareholders have been significant. Similarly, there have been a number of instances recently where companies have reported profit warning due to rising price of cotton (linked to drought). Having a better understanding of their resource dependencies and their exposure to price rises from factors such as water scarcity can help them reduce their profit risk. Forward thinking companies are better managing these risks and are therefore more future proofed, likely to be better able to exploit new markets, avoid the worst of commodity price volatility and should ultimately be a better investment in the long term.
Emerging Markets ESG: What distinguishes SRI from mainstream investment?
This links to my previous point. I think that we are seeing a convergence in sustainable investment and main stream investing. Some of the principles of sustainable investment are being considered by the mainstream even if they don't classify it as that. For example, most mainstream mining analysts would look favourably at a mining company that manages its resources well and has good social and health initiatives in the local communities it operates in because it is more likely to keep its license to operate, be more successful in competitive situations and have a healthier and more productive work force. There is still a long way to go though and there are many ESG indicators that mainstream analysts could be looking at that would add value to their investment analysis. There is also more that needs to be done from ESG research houses to make their analysis more relevant to main stream investors, to demonstrate the links to financial returns and enable them to integrate research into their valuation models. This is why Trucost translates all its environmental risk research into financial terms, to enable investors to understand what the potential financial implication might be to a company from their natural capital dependencies and integrate that into their valuation scenarios.
Emerging Markets ESG: Which extra-financial theme - environmental, social or governance - is the most challenging for emerging market companies to manage?
I think the challenges vary in different markets so it isn't possible to say one is more challenging than another. It also depends on the sector, but broadly there is a need for greater disclosure of ESG indicators from Emerging Markets companies as they still lag the rest of the world in terms of their disclosure, which presents an investment risk due to the black hole of knowledge. Of course, it is impossible to disclose ESG indicators unless the data is being routinely collected in a systematic way which usually requires some management accountability, so in itself to have disclosure on issues, indicates that they are on the agenda of the company and they are beginning to manage them. This is new to many of the companies in the emerging markets so can be difficult for them to start doing. Many of Trucost's clients therefore ask to use our modeled data for companies who do not disclose so they can understand what the potential scale of risk in their portfolio is and with which companies. Some investor clients also engage with high impact non disclosing companies to encourage them to improve their transparency. The quality of disclosures also needs to improve but there are some positive signs and some countries, like South Africa, are actually quite advanced in reporting due to initiatives by the JSE and things like the King Code of corporate governance principles... so it's not all negative!
Emerging Markets ESG: Which extra-financial theme - environmental, social or governance - is the most challenging for investors in emerging market companies to analyze?
A key trend we have identified is a desire from investors to understand the risk they may be exposed to through the supply chains of companies which are increasingly being moved to the emerging markets. This presents a set of risks that can be very difficult to unpick as there is often a lack of visibility in company supply chains, however, this is also where the greatest risk for a company and an investor frequently comes from. Sectors such as food and clothing production and retail are particularly exposed. We are working with clients, such as Puma, to understand their supply chain and their natural capital requirements such as cotton, wheat and leather and map those requirements to their suppliers' geographies and possibility of future price increases from factors such as water price rises. This insight enables companies to understand their supply chain and operational risk from natural resource requirements, identify and mange where in the world and from which suppliers their greatest environmental impacts are occurring, inform future business strategy such as sourcing and then define successful business models for a resource constrained future. It is evidence of this type of foresight that investors are looking for from companies.
Emerging Markets ESG: Emerging markets have a huge environmental footprint. What role do emerging markets play in Trucost's business, operations and strategy?
Emerging markets are a strategic priority for Trucost. We haveexpanded rapidly in the emerging markets recently and expect that to continue this year. We are working for clients in China, Brazil, South Africa, India and other parts of Asia and have local partners such as Syntao in China. We have also opened an office in Hong Kong from which we will service Asia. We also have a large number of clients who are based outside of emerging markets who are interested in understanding the environmental risk they are exposed to through their investments in the emerging markets so Trucost is working hard to further build out our data and research in the region. It an exciting area!
First published on Emerging Markets ESG