Investment Adventures in Emerging Markets


Managing Through Shades of Gray: Stewardship and Impact in Emerging Market Equities

The world is complex, and for active investors, the “right” thing to do is not always defined in black and white, according to Franklin Templeton Emerging Markets Equity’s Andrew Ness. Here, he shares why he believes sustainable investing is managed through shades of gray, explains what sustainable opportunities he’s seen in emerging market economies and what it means to be a good steward of capital.

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Emerging markets present a unique set of challenges for sustainable investing. Cultural contexts vary, as do their stages of development from an environmental, social and governance (ESG) perspective. This reality can pose dilemmas for investors seeking positive multi-stakeholder outcomes—for instance, where societal and environmental trade-offs exist. The world is complex, and for active investors, the “right” thing to do is not always defined in black and white. Instead, we believe sustainable investing is managed through shades of gray.

Core Stock Drivers: Structural, Sustainable and Stewardship

The core stock drivers for investors can be summed up in the 3S’s: Structural, Sustainable and Stewardship. Structural opportunities, sustainable earnings and responsible stewardship are therefore the foundations of an effective, long-term approach to emerging market investing.

  • The long-term structural opportunity in emerging markets—demographics, technology, and consumption—which provides the beta for investors.
  • Actively identifying and targeting companies with sustainable earnings power that markets are mispricing can provide alpha for investors.
  • And finally, the responsible stewardship of clients’ capital and the leveraging of company relationships to create value through constructive engagement provides the delta for investors. Focusing on stewardship, what does it mean, how does it drive day-to-day investment activity and what are some of the challenges in trying to implement it consistently?

The UK Financial Reporting Council’s Stewardship Code defines stewardship as “the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society.” The code also states that “asset managers cannot delegate their responsibility and are accountable for effective stewardship. Stewardship activities include investment decision-making, monitoring assets and service providers, engaging with issuers and holding them to account on material issues, collaborating with others, and exercising rights and responsibilities.”1

It is important to note that the code requires tangible demonstration of these actions, rather than just a statement of compliance.

One of our core beliefs is that we are responsible stewards of our clients’ capital, so how do we define it? Our definition of stewardship is straightforward. Clients entrust us with their assets, and it is our responsibility and goal that when we eventually return those assets, they are in better condition than when we received them.

Our stewardship approach impacts how we act as investors—integration of ESG and active engagement with management; how we treat our clients by putting them first and being responsible fiduciaries; and how we behave as a business by being a responsible global citizen.

I was mentored by a very traditional investor in Glasgow who regularly reminded me about the purpose of asset management—which is not just about beating an index—it is a stewardship role that includes providing long-term capital while acting as a co-owner in a business to protect a client’s interests. That purpose has now expanded to one where we have broader societal responsibilities.

Essentially, we are looking to ensure that the growth of our portfolio holdings is done in a sustainable manner and that it does not compromise other stakeholder interests. We do that by leveraging our deep relationships and cross-border expertise to create value through constructive engagement.

Path to Sustainability

From an investment industry perspective, we have seen an early focus on sustainable investment in emerging markets evolve to move away from a risk-assessment focus toward ESG and sustainability—where investors have recognized that there are externalities and stakeholder challenges facing all companies in all geographies that need to be analyzed and incorporated into investment analysis.

More recently, ESG and sustainability have evolved toward the concept of sustainable investment and development, which is a long-term, multi-stakeholder approach to value creation with a greater focus on real world outcomes and quantifying impact.

Sustainable Investment Opportunities in Emerging Markets

With respect to emerging markets, the evolution of sustainability is just as important as the growth opportunity. However, several development challenges need to be addressed.

We expect ongoing, robust emerging market growth over the coming decades to drive urbanization and demographics, supporting additional growth drivers of consumption, connectivity and innovation. Demographics should remain supportive of global growth as the world’s population is projected to rise, with urban growth largely generated from emerging markets. This growth, however, is not without its challenges, as highlighted the United Nations Sustainable Development Goals, which predict a significant funding gap in emerging economies that cannot be met by government spending alone. This means that there is a significant role for private capital to play in addressing the challenges of poverty, rising inequality, health and wellbeing, finite resources and climate change.

In response, we’ve seen a rise in corporate awareness, particularly from private enterprises. Many forces are driving this. For example, we are seeing a “societal pull and regulator push” in many emerging markets. Local government policymakers are also leading a new wave of governance and stewardship, while supported by voices from various stakeholders—and not just shareholders.

Stock exchanges are asking for more disclosures from companies; many are initially voluntary in nature but will eventually become mandatory. And finally, companies themselves are increasingly more open to engagement, and we have seen tremendous improvement in ESG disclosure in recent years, albeit often from a low base.

The Socio-Environmental Challenge

We are seeing a growing use of exclusions and divestments as a solution to shape the societal and environmental outcomes that we seek. Divestment agendas are top of mind for investors, who are pushing asset aligners to position themselves with supposed best practices.

But what happens when societal and environmental trade-offs occur? Thousands of emerging market communities where the local mine supports livelihoods will be impacted when those with unsustainable practices are forced to close. Or, for example, calls for a coal-dependent country like India to reduce its usage. In our view, energy security and its vital role in economic development is far more important than long-term climate trends, from a broader societal perspective.

The reality is, these exclusions apply to countries with human rights violations, which in many cases can force businesses to cease trading through a divestment agenda, that can often hit the most vulnerable, local workers the most, leaving the intended real targets of political leadership, unaffected.

Ultimately, we see ourselves as pragmatic investors who recognize that the world is imperfect. The perfect company rarely exists. We believe compromise and a flexible approach is required when investing in emerging markets given the multiple shades of gray we encounter.

For timely investing tidbits, follow us on Twitter @FTI_emerging and on LinkedIn.

What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.

Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.

Important Legal Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as of publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

The opinions are intended solely to provide insight into how securities are analyzed. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio. This is not a complete analysis of every material fact regarding any industry, security or investment and should not be viewed as an investment recommendation. This is intended to provide insight into the portfolio selection and research process. Factual statements are taken from sources considered reliable, but have not been independently verified for completeness or accuracy. These opinions may not be relied upon as investment advice or as an offer for any particular security. Past performance does not guarantee future results.

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1. Source: Financial Reporting Council. The UK Stewardship Code, 2020.

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