Responsible Investment in Emerging Markets and CalPERS’s new 8 principles in EM

In Kuala Lumpur a few thousand airmiles ago, my feature presentation on Responsible Investment in Emerging Markets covered three segments, firstly the State of RI in EM, secondly the Future of RI looking to 2012, and finally the Challenges and Opportunities for RI in EM thru 2012 by invitation of The International Corporate Social Responsibility Conference 29th-31st July, 2008. The state of RI in EM in 2008 reflects the broader RI movement history. Responsible investing has grown over the past 30 years in piecemeal fashion driven by issues – think napalm, apartheid, SOX and NOX, Darfur - and waves of investors from institutional and retail segments, as Steve argues in our forthcoming paper [Lydenberg & Sinclair, forthcoming Journal of Business Ethics, 2008]. Indeed, sometimes the changes at micro level are curious - one SRI fund tracked out of Boston (Dreyfus Third Century-DRTHX) has been seeing big inflows these first weeks of August. The main focus of RI has been and remains on equities - the stocks of large, publicly traded corporations. This emphasis on equities is perhaps accounted for by the emphasis within the early RI movement on changing corporate behavior in positive ways and the desire of religious investors to avoid companies involved in morally questionable lines of business. It also skews away from where much of the ESG investor action in EM happens, in fixed income, family-owned small/medium enterprises [SMEs], and company capital projects.

Malaysia has since 2006 required all listed companies to report on their corporate responsibility policies and programs to Bursa Malaysia, the Malaysian Stock Exchange, and the Malaysian Treasury has been active in describing listing CSR requirements. But listed equities always only form a small portion of economic and business activity, especially in SE Asia where family wealth and private companies, as well as parastatal companies, form a major component of capital ownership and business activity. If sustainability or CSR aims to cover more ground, asset classes from the investment horizons outside of equities must be covered. Currently we are scoping a more comprehensive view on private equity and high net worth investor activity.

Demand for ESG in investment analysis coverage in developed countries has led to increased and improved supply [off a nothing base]: mainstream investment houses, such as Société Générale, F&C Asset Management, HBOS, Citigroup Smith Barney, JP Morgan Chase, Merrill Lynch, UBS and Goldman Sachs have in recent years established in-house research teams that conduct analyses for their investor clients on such issues as climate change, renewable energy, water, human rights, nutrition and diversity. Some of it is eased along by the Enhanced Analytics Initiative [EAI], but as a mate reports even this year in 2008, the EAI offering for EM investors is thin. I agree with Marcel Jeucken of PGGM, the second-largest Dutch pension fund, that there is “low hanging fruit in EM from an ESG perspective” [Responsible Investment Landscape Report: Asset Managers, 2008]. PGGM considers EM from a human rights perspective including covering “oppressive regimes” [undefined], and they reportedly cover fully 1,000 EM companies of the 4,000 companies universe screened. EM is sometimes regarded as an illiquid asset class, based on the volatility and some settlement challenges.

Direct and Indirect

In my EM session, one sensed the audience leaned forward when I covered the roles of investors within a country and into a country, foreign versus local capital, a truth in tension in EM. The 1997 Asian currency meltdown was a “where were you when…” moment in the region’s history ["Soros" remains a four-letter word]. The ‘97 crisis, as one local expert explained; “took away not just the investor focus and funds but internal drive as well”. What foreign investors think, and do, is important to Malaysian investors. Today the regional rivalry with Indonesia, Singapore, Thailand and similar countries is real. The conceptual framework I developed for the PRI in EM Project [now being taken on by my former intern, Narina Mnatsakanian, recruited from KPMG Netherlands] on investors directly or indirectly into EM was usefully adapted for the Malaysian presentation.

The graphic [see above] illustrates the role of portfolio flows in EM, and three points of investor exposure – including the third category where GE fits in, noting that for the first time ever, in fiscal 2007 more than 50% of GE’s revenue came ex-USA. Going forward, the relative power of family wealth, private companies and company capital investment including M&A must be factored into the thinking. The EM Investor framework explains the relative roles of foreign portfolio, local portfolio as well as company supply and demand chains across borders into EM. For example, in February 2007 California Public Employees’ Retirement System [CalPERS] committed US$400 Million to a new private equity vehicle focusing on global emerging markets in Eastern Europe, Latin America and Asia.

I explained our experience of ex-country investors sitting in San Francisco, London or Zurich who use a tool like the MSCI Barra EM Index as universe and benchmark for their EM exposure. The last public data had Malaysia represented 3.052% with $79,193 market cap and 58 companies, the ninth largest allocation and fifth of five ASEAN countries in the top 10. Malaysia is a major component of an EM perspective. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The embargoed website lists the MSCI Emerging Markets Index as of June 2006 consisted of the following 25 emerging market country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. In the UN context of course, Taiwan’s massive market cap [US$ 688bn at 31 Dec 2007] was wished away to cater to the China politics.

The perspective of foreign investors may be as influential as sovereign ratings agencies, and of course they are self-reinforcing. This week the price of South Africa’s long delayed electricity grid upgrades just got a lot more expensive when all three ratings agenices downgraded ESKOM debt, forcing the treasury to promise to underwrite it and the path to the World Bank to be trodden once again.

Eight Principles

In the institutional investment space, whatever US giant CalPERS does is watched closely, slightly less than more paparazzi friendly targets in California, like Britney Spears or Jack Nicholson… Noteworthy for EM investors, in December 2007 the CalPERS Investment Committee moved away from a negative-screening-on-country approach in existence since 1989 toward a new principles-based approach to investing in the emerging markets in lieu of the existing country list and permissible equity market analysis adapted from the FTSE All Emerging Index [evidence of CalPERS market power and the competitive nature of the index business that they chose not to use the industry de facto standard, MSCI EM Index]. Apparently, the time and resource costs out-weighed the ESG benefits - former CalPERS analysts admitted the policy consumed hundreds of hours of staff and consulting time. In April 2007 when the review was announced, Mark Anson — CalPERS’ former chief investment officer and then chief executive officer of Hermes Pensions Management Ltd., London [he returned stateside a year ago citing personal changes], wrote in an e-mail to Pensions & Investments “I am encouraged by statements of Chuck Valdes and other board members to review the emerging markets policy. Emerging markets are the most dynamic part of the equity markets, where change is rapid and investors must be both prudent and flexible to achieve the best possible long-term returns.” Media also reported the emerging markets list had cost the fund 2.6 percentage points annually in performance — or $401 million in opportunity costs — from Aug. 1, 2002 through Dec. 31, 2006. Together with busloads of citizens from targeted EM countries, clearly an unwieldy but well-intentioned effort that attracted debate over the years, as far back as 2002.

The new approach, GLOBAL PRINCIPLES OF ACCOUNTABLE CORPORATE GOVERNANCE, was reported by Cal PERS as “continues CalPERS’ policy of being a positive influence for improved practices in emerging markets, while increasing the opportunity set for CalPERS’ managers”. The eight principles cover a mix of ESG factors, including the major of political institutions, illustrating a delicate crossover of investor and the public sectors [extracts below]:

· A. Political Stability – including what I rate as the more important factor, Civil liberties: 3. Independent judiciary and legal protection:

· B. Transparency – including elements of a free press necessary for investors to have truthful, accurate and relevant information [biggest ticket item for me] and stock exchange listing requirements [more on the Brazilian experience at BOVESPA next week].

· C. Productive Labor Practices.

· D. Corporate Social Responsibility and Long-term Sustainability - Includes Environmental sustainability and the Global Sullivan Principles of Corporate Social Responsibility [see new website at http://www.thesullivanfoundation.org/gsp/default.asp].

· E. Market Regulation and Liquidity – including “little to no repatriation risk”.

· F. Capital Market Openness .

· G. Settlement Proficiency/Transaction Costs

· H. Appropriate Disclosure

The document introducing “The Global Principles of Accountable Corporate Governance” describes the framework by which CalPERS puts into action its proxy voting responsibilities in addition to providing a foundation for supporting the System’s corporate engagement and governance initiatives. The aim is “to achieve long-term sustainable risk adjusted investment returns”. It is unclear how this objective will be measured, and over what time horizon. CalPERS does break new ground in developing their own approach that does not naively map to a smorgasbord of acronym international initiatives, similar to the Fins and Danes. CalPERS also offers some material on their universal owner perspective, namely “[CalPERS] has chosen to adopt the term "shareowner" rather than "shareholder." This is to reflect a view that equity ownership carries with it active responsibilities and is not merely passively "holding" shares. Perhaps the strongest takeaway for any investor is the quote from CFA Institute’s take on Corporate Governance: “For corporate governance structures to work effectively, Shareowners must be active and prudent in the use of their rights. In this way, Shareowners must act like owners and continue to exercise the rights available to them.” (2005 CFA Institute: Centre for Financial Market Integrity, The Corporate Governance of Listed Companies: A Manual for Investors)

How decisions on the eight principles are made, and indeed the relative weightings on decisions [for example, when would a country perspective on China trigger a review?], may reflect the pragmatism necessary in investment in general, and especially in ESG. I look forward to the first review of the new principles based approach next year, and comments from similar institutional investors I met this year in Singapore, Rio de Janeiro, Cape Town, London, New York, Boston and Dubai. As many before us have learned in sustainability+investment, the pragmatic trumps the politics.

Air conditioners in Singapore, drunken Tree Shrews in Malaysia

The best invention ever? The air conditioner. My Singaporean friend smiled as he offered this declaration by a Singaporean statesman on my first visit to Singapore and Malaysia this week. Choon is a good man, works in Pharma in SE Asia, sometime rugby player and U of Michigan Ross School MBA alum. I was invited to Malaysia to cover my EM work for CSR and SRI experts at The International Corporate Social Responsibility Conference 2008 jointly organised by the EUMCCI, OWW Consulting and RUSS Consulting, 29th-31st July in a feature presentation on Responsible Investment in Emerging Markets. The region must be one of Carrier or LG or Dakine’s best sales areas. I expect few expats from cooler northern climates in the financial district’s highrises would last long over their XLS spreadsheets without a steady 72F/19C! But what of the climate impact? I’m still waiting on word of how many units are sold without CFCs, and like any competitive and emerging society, I suppose many may be serviced by solo entrepreneurs in small shops doing the best they can, with or without ISO certifications. The climate impact of the air conditioner business post Montreal Protocol, from manufacturing to consumption patterns, maybe worth a paper from my old mate at UNEP working in the Global Environmental Fund.

Walking the streets of SIA and KL has added colour and texture to my understanding of the SE Asia region beyond three letter airport acronyms. Singapore has always been pitched as the goto for investment in the region, and Malaysia has been interesting for me ever since the massive investments in post-apartheid South Africa in 1994/5. It has the similarities with affirmative action and economic empowerment and the tied destiny in the 1997 Asian flu that whacked the South African rand as traders rushed to quit any EM exposure and the ZAR was so liquid [regularly in the top ten most traded currency]. SE Asia is understandably complex, and research rewards the curious, but one needs the street-skills typical of EM. How to explain the site of a bay of waiting cargo ships, the mixed low and high rise properties, curry for breakfast, white bean hot drink, wakeboard center open until 11pm on Saturday night, and dainty bakery items my mum would be proud of baking [I was reprimanded for taking a photo - since when did baked goods become so competitive?!]?

One needs to be on the ground in SE Asia to properly assess performance, especially for understanding environmental, social and governance [the ESG in sectors report is a good illustration Taking Stock — Adding Sustainability Variables to Asian Sectoral Analysis]. The usual pitches by the hotel and the airport to being green were in evidence. The “onsite” argument view was confirmed in conversation with a respected colleague and expert in the region, a former i-bank analyst heading ASrIA. The data is there, what is and is not being done. But one needs to dig for it [the blunt tools of questionnaire and engagement letter are ignored], and the data or its information is not necessarily well-organized. Covering ESG performance in SA Asia may benefit those with the raw data and local knowledge to analyze it. The information asymmetry benefits locally based players in the ESG space, like Fortis, Aberdeen and Lazard. As a former HSBC guy turned business journalist at Channel 7 explained, sharing a story of how his team, in trying to sort lending exposure post the 1997-meltdown, posted his own people to stake out a factory for a couple of days to see how it was really doing, counting movements of widgets to assess inventory, as opposed to the smiling handshakes of the planned visit which hid the real activity driving the factory cashflows.

The International Corporate Social Responsibility Conference 2008 was hosted at Hilton Kuala Lumpur with its four storey window overlooking twisting highway and lush treescapes a few kilometres from the city center of the Lake Gardens. Day One was CSR focused, Day Two on RI, with Day 3 trying to square the circle with the WBCSD workshop. I was most interested in understanding what was actually being done on the ground by local firms. Geoff Williams at OWW Consulting and other local partners have done good work presenting this conference with CSR and SRI days back-to-back, with the WBCSD workshop tomorrow hopefully putting investors, corporate CSR and company development people in the same room. This is another stop in the project to assess the presentation of the sustainability proposition by companies to investors. I met Geoff when I was leading the PRI in Emerging Markets Project at UNEP FI, where Geoff was a positive in building momentum in the region [expect more on the PRI in EM project in future posts]. Geoff, myself and two academics from the local university covering sustainability, USM, will be moving forward on a mapping survey on RI later this year, building on my work with the similar mapping in SA last year – we’ll be keeping lead author in SA, Neil Eccles at UNISA Centre for Corporate Citizenship, looped. I prefer to work collaboratively. Old PRI colleagues at NZ Super amongst others will be supporting the survey. Universiti Sains Malaysia [USM] is positioning itself as the leading sustainability university in Malaysia (in Asian fashion, it has its own USM song). The survey will cover attitudes to RI in Thailand, Korea, Singapore and Malaysia from asset owners, investment managers and service providers. While not groundbreaking, if we build with the appropriate rigour, it may form the basis for a decent view on the state of play, comparison and contrast to the South African State of Responsible Investment study in 2007, and I will look to replicate it in Latin America and Eastern Europe in 2009.

My connecting WBCSD and OWW was important to increase the EM exposure for the WBCSD Business Theme valuation project by getting to Malaysia, and closing the gap between corporate and investor perspectives. Ten CEOs were expected for the workshop on Thursday, and a representative sample of investors [I will cover the project in more detail in Q4 2008]. The WBCSD project will explicitly cover the perspective of multinational companies, local operations of MNCs, as well as local EM country champions. I look forward to the South Africa event at the JSE in November. As with any of these initiatives that I deal with across the sustainability theme – and there are too many of them – I continue to make the case for real, on-the-ground input and activity from an EM perspective.

In my presentation on Responsible Investment in Emerging Markets, by show of hands, there were just five investment professionals in the hall. Most of the 250 delegates were corporate CSR, NGO, academic or public policy people, except for the likes of Anne-Maree O’Connor from NZ Superannuation Fund, Colin Melvin, CEO of Hermes Asset Management (UK) which manages the £35 billion British Telecom Pension Fund, Kris Douma, Head of Responsible Investment Support & Active Ownership at Netherlands based Mn-Services [we met at the Institutional Investor event in Amsterdam in March], which manages €65 billion and Alexis Krajeski, Governance & Sustainable Investment expert, F&C Investments, (UK) which invests more than £100 billion in Socially Responsible Investments [now moved from Boston to London]. YK Park, project Director at ASrIA, covered the Carbon Disclosure Project [CDP] work – ASrIA acts as regional partner for CDP, for example the 2007 CDP5 report. ASrIA has played a key role in opening doors for investors from outside the region. I was hoping YK would offer more information on how the CDP data is being used by investors and CDP members. Understanding the investor impact – and increased use of CDP data – must be measured for a sense of CDP’s impact, a project I have motivated CDP to move on globally in 2008/9.

To hook my insights on EM and ESG in “Responsible Investment: the experience in emerging markets“, I used a little fact I picked up from the BBC Tuesday night to act as metaphor for my speech, see “Malaysian tree-shrew is heavyweight boozer” BBC 29 July 2008. The connection was to the fact that scientists had only just discovered some rather unique behaviour of the small forest creature, how they measured behaviour, and how tracking it over time gives us metrics on how it thrives, including whther it will still be around in 2012.

A tiny tree-shrew that lives on alcoholic nectar could - pound for pound - drink the average human under the table – Proceedings of the National Academy of Sciences . Malaysia's pen-tailed tree-shrew waits until nightfall to binge on fermented nectar from the bertam palm. Insights into how humans' alcohol tolerance first evolved.

The photo was used to reflect 3 messages on “Responsible Investment: the experience in emerging markets“: context, facts, and metrics. My view is that, to understand where RI is and where it may go through 2012, one must appreciate firstly, the socio-economic context of each country [attitudes toward sustainability and ranking of ESG factors will vary], secondly, facts are important and data is available but may need better discovery with better analysis in that cultural context, and finally, the importance of measuring where RI in EM is going, including understanding the appropriate metrics over time per region or country. The message fits the intersection of sustainability and investment where I work. While outside the geographic coverage [Brazil and UK] of the Natural Value Initiative on biodiversity headed by Annelisa Grigg and my former UNEP FI colleague Susan Steinhagen, I think the shrew fits neatly into the fundamental question: how may investors better quantify the biodiversity value of ecosystems? How much is the scientific discovery of this behaviour worth? How much is each shrew worth?

The audience was typically Malaysian (or so my hosts tell me): in the Q&A session – for the first time ever in my public speaking career - no questions! In a region where culture dictates no losing face and reticence amongst strangers, at least in general session, 250 polite people stared back at me. I smiled. This is what you learn when you fly halfway around the world…