ESG considerations are also emerging strongly in emerging markets portfolios. Many investors want to contribute to change in countries that often still have a long way to go. This process of change can also be one of the drivers of financial outperformance, say Basak Yavuz and Kay Haigh, portfolio managers at Goldman Sachs Asset Management.
The application of ESG criteria (Environment, Social and Governance) in emerging markets is more complex than in more developed markets. This is primarily due to the scarcity of good and reliable data, says Basak Yavuz, manager of emerging markets equity portfolios at Goldman Sachs Asset Management. "There is a lot less transparency than in developed markets. This makes it important to have expertise in local markets, to be able to distinguish the winners from the losers, to find those companies that actually apply ESG criteria."
The challenge of data scarcity is also an opportunity, Yavuz argues. "If you do your job well, you can stay ahead of the competition and generate outperformance for investors. ESG in emerging markets remains in constant flux." She points out that on the equity side alone, Goldman Sachs Asset Management has 25 analysts working in this area, with an average of 17 years of experience.
ESG and government bonds
The differences in ESG scores between countries and companies are large. This divergence also makes it possible to generate outperformance with strict ESG criteria, says Kay Haigh, manager of fixed income portfolios in emerging markets at Goldman Sachs Asset Management. "In the case of government bonds, this seems a little more difficult than in the case of individual companies and corporate bonds, but here, too, you have many instruments. For example, we look at the legal system of a country, the independence of its central bank, income distribution and access to the labour market. We also look at social unrest. These are all important variables that help us generate alpha," says Haigh.
The main issue, according to Haigh, is momentum. "Many ESG scores are static and are retrospective. We are therefore looking not so much at a country's absolute ESG score, but at its improvement. This provides upward potential in terms of return, but it is also an opportunity to stimulate the sustainable or social development that you want as an investor. This does require that you also have the ability carry out a forward-looking analysis for countries."
“Also, for some companies, the absolute level of the score might be less important than the momentum, confirms Yavuz. She states that in emerging markets there are now many companies with excellent ESG score. "But that is reflected in the valuation. A company with good and improving ESG credentials offers more potential for performance and you want to be in those companies", says Yavuz. “
According to her, engagement plays an important role here. "Companies like to engage with us because we have a lot of ESG expertise, thanks in part to our experience in developed markets. We do want to see a path of improvement, visible through milestones and actual investments, for example. Otherwise, we will withdraw," Yavuz says.
Dynamic risk management
Emerging markets offer investors the opportunity to invest in economies that are growing relatively quickly. They take the higher volatility for granted. ESG is not only a way of generating outperformance, but can also be a good way of limiting risks. After all, poor governance, underpayment of staff or environmental pollution are ultimately things that can weigh heavily on a company's results in the long term. The exclusion policy ensures that shares and bonds with a very poor ESG score are not included in the portfolios.
According to Haigh, it is also important to be ahead of the game by estimating where the next wave of volatility in the markets will come from. Good diversification is equally important. "With government bonds, we look beyond the distribution of around 80 countries, but have created a diversified portfolio where the risk does not depend solely on the country distribution. For example, we make classifications according to the state of the fiscal economy, the sensitivity to commodity prices and the sensitivity to world trade. After all, you don't want to have too much exposure to one specific risk factor."
Covid has firmly expanded the number of relevant risk factors, Haigh points out. "Factors we didn't look at much before became important very quickly. Think of tourism, healthcare and capital flows of emigrants to their country of origin." At the same time, the pandemic gave new impetus to ESG, Yavuz argues. "It taught people that we do not have complete control, but that we can improve things. For example, the lockdown made clear that we can indeed improve air and water quality."
Keep up to date with what’s happening in Emerging Markets with the latest insights from Goldman Sachs Asset Management.
Disclaimer:
HIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO.
Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant.
This material is provided for informational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. This material is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client's account should or would be handled, as appropriate investment strategies depend upon the client's investment objectives.
Capital is at risk.
Diversification does not protect an investor from market risk and does not ensure a profit.
Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.
This article is provided for information purposes only and do not constitute legal advice. If you have any queries regarding the contents of this article, you should contact your legal and other professional advisers. By providing the requested information, you agree that your responses are and shall be treated as representations and warranties as to your status. We will rely on the information you provide when reporting on your behalf. To the extent that any information you provide is incorrect, this may result in a breach of your legal or regulatory obligations and/or representations and warranties given to counterparties on your behalf.
Switzerland:
For Qualified Investor use only - Not for distribution to general public
This is marketing material.
This document is provided to you by Goldman Sachs Bank AG, Zürich. Any future contractual relationships will be entered into with affiliates of Goldman Sachs Bank AG, which are domiciled outside of Switzerland. We would like to remind you that foreign (Non-Swiss) legal and regulatory systems may not provide the same level of protection in relation to client confidentiality and data protection as offered to you by Swiss law.
This financial promotion is provided by Goldman Sachs Bank Europe SE
This material is a financial promotion disseminated by Goldman Sachs Bank Europe SE, including through its authorised branches ("GSBE"). GSBE is a credit institution incorporated in Germany and, within the Single Supervisory Mechanism established between those Member States of the European Union whose official currency is the Euro, subject to direct prudential supervision by the European Central Bank and in other respects supervised by German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) and Deutsche Bundesbank.
In the United Kingdom, this material is a financial promotion and has been approved by Goldman Sachs Asset Management International, which is authorized and regulated in the United Kingdom by the Financial Conduct Authority.
Confidentiality
No part of this material may, without GSAM’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.
© 2021 Goldman Sachs. All rights reserved. 251927-OTU-1470890.
T