ESG INVESTMENT IMPLICATIONS IN EMERGING MARKETS, AND OLYMPIC-SIZE CORRUPTION

Weekly Viewpoints on Sustainable Investment 

In this week's note some reflections from a global webinar on emerging markets, looking across to Brazil and ahead to PRI in Person in Cape Town. 

Low altitude sky view of Cape Town harbour and city centre toward Table Mountain, 9 July 2013. 
PHOTOCREDIT: Jean Tresfon, by permission. http://www.flickr.com/photos/jtresfon/

EMERGING RULES OF INVESTMENT     

The rules of investment are different in frontier and emerging markets. Even before the start of the 100th edition of the Tour de France 13 stages ago, I had taken to explaining the gaps between regulations and realities in investment by using the example of cyclist Lance Armstrong (first "I never tested positive" for a decade, then that tear-jerker Oprah Winfrey half-apology apology). Investment, and investment analysis, in frontier and emerging markets happens across borders of regulations, guidelines and laws. The SinCo Investment Philosophy is that there is ESG in every investment decision in the global professional investment management industry, sized at $62 trillion by BCG. Sustainable investment is proactive approach to advanced investment management through integrating ESG factors. It is a broad term, and details matter. None more so than when investing in frontier and emerging markets, the subject of Thursday's global webinar hosted by MSCI ESG "ESG Investment Implications for Emerging Markets". My view remains that "emerging markets" tag is a sweeping simplification, useful in the 1980s when coined by the IFC, redundant in this decade. China has an orbital manned space program, India launched a missile from a submarine platform. Emerging?! We have a competitive economic marketplace in which "[c]hanging trade patterns show, the BRICs and the N11 becoming bigger should make us all wealthier in aggregate...the view of the BRIC countries becoming bigger than the US before 2015, and bigger than the G7 by 2035..." according to Jim O'Neill in his last note "The World Still Needs Better Economic BRICs" in April 2013.

My presentation to the global webinar covered two major themes (slidedeck here http://slidesha.re/13DiVpC):

A. Beyond BRICS countries, towards frontier markets and frontiers of ESG:  

1. Defining your universe of opportunity, and your portfolio entry points. 
2. Understanding the license to operate of professional investors and their portfolio companies. 
3. The scope of rules and regulations is smaller than global reputations. 
4. Relationships are critical in markets with more forms of alternative ownership models and new offerings.

B.  PRI in Person outlook, the enigmatic Africa opportunity: 

1. PRIiP2013 has an important footprint effect for PRI, leveraging strategic opportunity in Africa.
2. Introduces opportunities in fragments, the frustrating search for scale. 
3. The asset allocation decision and sector exposure may be more important than the geographic universe opportunity in Africa. 
4. Will the PRI legacy be more than FIFA FWC 2010?

ESG may act as a proxy for advanced due diligence or a marker for absent rules in the marketplace. Food and beverage products with a good reputation are critical to food and beverages companies, as well as their investors, regulators, consumers, and politicians. Food is politics, never more so than when analysis by FAO and OECD predicts that cheap food is history. The Access to Nutrition Index project has illustrated to me that making ESG happen in growth markets will reveal limits to ESG data coverage, national differences in reporting, culture differences, language and jargon barriers, and opportunities to re-interpret ESG concepts. 

PRI ANNUAL EVENT COMES TO AFRICA

Africa introduces opportunities in fragments, and may frustrate businesses and investors seeking for returns to scale, because the continent is so diverse, and so large. For investors seeking exposure to the Africa growth story (not the McKinsey-esque hype, the other story based in reality), I suggest exploring the asset allocation decision and sector exposure. Choosing the right sectors, and which asset classes to invest through may be more important than the geographic universe opportunity to be had in covering Africa. At SinCo we encourage thinking that mirrors the business being done in emerging markets, following anchor industries with multi-stakholder high-impact, high-visibility sustainability profiles, for example, investing in frontier markets in the mining sector faces issues of resource scarcity, above-ground risks, lesser regulated jurisdictions, community pushback, transparency, the "Bumi syndrome" where historical, relational business collides with expectations of corporate governance. So investing in this theme will track a material economic and sustainability trend. The Africa growth story is overplayed. This is demonstrated plainly by the latest UNCTAD report describing intra-Africa trade barriers, often experienced by overland travelers and trucks by hours-long border crossings. 

And so the annual event machine that is the PRI in Person event is cranking up for the conference 1-2 October being hosted in Africa for the first time. Like the FIFA Football World Cup 2010, it will be in Africa's largest economy, South Africa. Africa has been represented in the Principles for Responsible Investment (PRI) from the start by Africa's largest sovereign wealth pension fund, the US$131 billion AuM Government Employees Pension Fund of South Africa. The PRI South Africa network was one of the first country networks, illustrating the take up by investment managers and services providers, asset owners have been largely absent. John Oliphant, Head: Investments & Actuarial, has lobbied hard to get the annual show onto the continent. I was at a particularly frank meeting of stakeholders in 2010 when investment professional colleagues were left staring at their notepads as questions about making responsible investment happen in Africa were hanging in the air over the boardroom table at GEPF headquarters in Tshwane. 

The PRIiP2013 agenda has taken shape for the 2 days (http://www.unpri.org/events/pri-in-person-cape-town/). I am pleased that private equity is receiving specific attention, albeit outside the formal program on 4 October and have supported the PRI team in London with designing the program, and encouraged the co-work of private equity associations AVCA and SAVCA. PRI is being hosted in a city, within a country and on a continent that has a long history and a demanding current reality. PRIiP2013 delegates do well to scale their rhetoric to the realities. Impact, longevity and equity matter: global asset management is $63 trillion, only $450 billion in emerging markets. Will PRIiP2013 leave a better legacy than FWC2010? FIFA made a tax-free $1 billion in 2010, forced the building of the beautiful white elephant stadium in Greenpoint, Cape Town, and stoked a corruption wave in South Africa that saw a whistleblower assassinated and that is today still playing out with construction companies "facing a firing squad" according to the CEO OF Murray & Roberts (OTCMKTS:MURZY). Corruption is a two-way deal. Sustainable investment aims to come down hard on corruption in business, and most ESG dashboards have pretty sophisticated approaches to filtering governance failures. The details of how the market was manipulated needs to be further understood. Meanwhile construction companies governance scores in South Africa will have tanked. 

CONSTRUCTIONS FIRMS AND WORLD CUPS/OLYMPICS: IT'S COMPLICATED

Based on the largest street protests in a generation in fellow BRICS major Brazil, it looks like the role of construction companies, and their billion dollar contracts, will also play out. I am looking forward to the FIFA FWC2014 in Brazil (especially following THAT 3-0 hammering of Spain last week), and the Rio Olympics 2016. In the withering glare of the business media this week has been billionaire Cesar Mata Pires (Bloomberg: "World Cup Billionaire Stirs Brazil Protests Over Stadiums"). The 90% shareholder of construction firm OAS has benefited hugely from infrastructure projects, and has leveraged financing from Brazil's BNDES development financing bank. OAS has low income housing deals with Brazil's 3 largest pension funds which have an asset base 2x Luxembourg's GDP in 2012. BNDES saw its loans double since 2008 to 156 billion reais last year, twice the total lending of the World Bank. PRI Board member, PREVI, is the largest in Brazil, and is based in Rio de Janeiro. Apparently, a street protester's placard allegedly included "The $ for Education Went to OAS". Ouch! No doubt @BW journalist @BlakeSchmidt is off Mr Pires's scoop shortlist... Bloomberg reports that with the help of subsidized loans from Brazil’s state development bank, closely held OAS SA had revenue of $3.4 billion last year. The OAS head of investor relations Barreto described protesters’ "targeting of OAS is “ignorant” and “simplistic,” and that the company obeys the law...It’s the only existing business model in Brazil." In future posts I will offer some comments on alternative ownership structures and the role of the national governments in frontier markets in financing growth.

MARKETPLACE REPORT ON ESG IN AFRICA INCOMING AUGUST 2013

And finally, a quick update on the marathon project to roll out the AfricaSIF.org 2012 Trends Report (http://www.africasif.org/trends-2012.php). Along with the all-volunteer team of practitioners and graduate students across Africa, I have been working on nailing down the data, analysis and commentary for this first-ever report. The excitement in the report is this new analysis from Africa for Africa and the world. The team is now targeting the IMN Africa Cup of Investment Management 27-29 August for the start of the launch roadshow. This first-ever reporting of professionally managed assets investing in Africa with ESG in some way included in the process. Collaborative project includes GEPF, MSCI, Bloomberg, Investec Asset Management, SinCo, RisCura, Mergence Investment Managers, OMIGSA, and Frost and Sullivan. The survey estimates that the level of sustainable investment in Africa is high with about $233 billion AuM or 63.4% of total AuM of Africa investments is self-reported to be managed according to sustainable investment principles. This implies the African (competitive) market is material for sustainable investment firms, but also pretty scrappy to command market share. Research is costly, especially north of South Africa where reporting is thinner. This helps explain why all major ESG research shops now have decent large firm coverage in South Africa, and why MSCI ESG just hired their first Africa-based analyst starting end August 2013 in Cape Town. Good timing. Chris Froome, current race leader and likely the first Africa-born winner of Le Tour, may be lying on his couch wearing a yellow jersey by the end of July.

Do good work on sustainable investment that matters.

Graham Sinclair
@esgarchitect

Principal
SinCo - Sustainable Investment Consulting
www.sincosinco.com
@SinCoESG

Based on my work, experience and interactions, all views and opinions expressed are those of the author and do not reflect the named individuals, institutions or SinCo, it's clients or services providers. No mention suggests endorsement. This commentary does not constitute investment advise. Issued by SinCo to professional investors and stakeholders for information only and its accuracy/completeness is not guaranteed. All opinions may change without notice and may differ to opinions/recommendations expressed by other business areas of SinCo. SinCo may maintain positions and trade in collective investment instruments referred to. Unless stated otherwise, this is not a personal recommendation, offer or solicitation to buy/sell and any prices/quotations are indicative only. SinCo may provide sustainable investment architecture and other services to, and/or its employees may be directors of, companies referred to. To the extent permitted by law, SinCo does not accept any liability arising from the use of this communication.

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UPDATED 15 July 2013: Text edits, paragraphing, hyperlinks.

Building Sustainability Indexes

Building sustainability indexes is a specialist function for index architects. The Domini 400 Social Index has been running since 1 May 1990 as a benchmark for the obvious question: including ESG factors in selecting large US companies, how does it impact performance. The ETF tracks at iShares FTSE KLD 400 Social Idx Fd (ETF) (Public, NYSE:DSI). Over the years the DS400 has come to send many other messages, and practitioners know the strengths and weaknesses of this specific index, but it has established the role for the sustainability index. The purpose of an index must be clear in order to create focus for any sustainable investment approach. At SinCo we recommend that any index must be succinctly defined. Sharpening the sustainable investment focus is critical. Criteria matter. So does longevity. Many interesting variations will emerge in the design, development and ongoing execution of the index, and tensions within the mission and current programs may be expected. Maintaining focus prevails on the choice of work and work partners and the design of selection criteria. The Dow Jones Sustainability Index is now 10 years old [see the latest review with DJ here] and some of the people who helped build it like Alex Barkawi have moved on.

Our experience of sustainability indexes provides the empirical basis for design directions and development, interpreted by experts in sustainable investment and the role of indexes. The emergence of country-level indexes rather than international (for example DJSI Global) or themes indexes (for example, carbon or water). South Africa is an obvious example in emerging markets with the JSE SRI Index [up this year, together with Brazil (BOVESPA ISE) launched by the IFC in 2005, and India (S&P CRISIL/KLD/IFC), as well as emerging country examples in Egypt, Spain and South Korea, together with newer thematic indexes such as the Healthy Living Index (SAM) and international initiatives like the Carbon Leaders Index – CDLI (CDP/Innovest).

• SAM Sustainable Healthy Living Fund is designed to invest from the global stock universe in the most attractive enterprises along the health value added chain. For this purpose those trends which influence the Healthy Living-sector decisively are investigated in the first step by means of macroeconomic analysis.
• Carbon Leaders Index – CDLI (CDP/Innovest) The CDLI scores for the Global 500, Europe, FTSE 350, and S&P 500 companies are now used by index provider Markit to create a family of equity indices.
  

Index architecture must map to the investment case and the index proposition. We will cover the impact of sustainability indices separately, other than to say now that sustainable investment indexes have an impact, but a complex model is needed to assess the impact. Indexes (and indexed portfolios) are actively managed investment instruments that are constructed according to objective criteria and are compiled and marketed by financial services firms such as FTSE Group/Financial Times [www.ftse.com/Indices], Morgan Stanley Capital International Indexes [www.msci.com], Standard & Poor’s Indexes [www.sandp.com] and Dow Jones Indexes [http://www.djindexes.com/].

Index membership literally confers “investment grade” on firms because numerous managed funds are benchmarked to, or directly invested in, these indexes. Where the index is themed, selection into the “club” confers a certain halo effect or positive association for that company because there has been a dramatic increase in the scale of funds that directly track market indexes. Gaining and maintaining membership in an “index club” is often a critically important goal for company executives. As with any differentiating characteristic, companies seek to gain competitive advantage with investors, prospective employees, and other stakeholders, and a high ranking in an index can give them such an advantage.

When a company is ranked or included in an influential or prestigious index such as the Dow Jones Sustainability Index (DJSI) or the Fortune 100 Best Companies to Work For, the company will reference that fact, especially when that firm is looking to present credentials as being “world-class”. For example, Brazil petroleum major Petrobras [Petroleo Brasileiro SA (ADR) (Public, NYSE:PBR)] lists five accreditations on a full-page color advertisement in a magazine targeted at investors and company executives (Bloomberg Markets magazine, December 2009), including membership in the DJSI. On the other hand, exclusion from an index can encourage companies to pledge changes. When Daimler [Daimler AG (Public, ETR:DAI] and Bayer [Bayer AG (Public, ETR:BAYN)] were excluded from the DJSI STOXX, their reaction in the German business paper Handelsblatt on 8 September 2008 ranged from pledges to improve (“We will definitely intensify our efforts regarding sustainability”, according to a spokeswoman from Daimler AG) to surprise at being excluded (Bayer commented, “We are not happy about it and we will try our best to be included again, since this is increasingly relevant to us on a financial basis. However, it will be more and more difficult to achieve inclusion in this benchmark.”). Our experience is that ratings, rankings and indexes may be a powerful tool for driving forward sustainability and creates a signaling effect across sectors and stakeholders. At this time we do not delve into the detail of ratings, rankings and indexes. There exist many different approaches, and characteristics of each of the three may be quite different, offering different value propositions that the index leadership must address at the outset of their goal and objective setting stages. Indexes are a feature of any discussion, a reference point, and quite literally a benchmark. Sustainability indexes can be even more so.