(Corrects to show Rana Plaza factory was collapse, not fire)
* Emerging equity investors embrace sustainable investment
* Financial crisis, disasters have led to increased focus
* Returns may be higher, but definitions sometimes unclear
By Carolyn Cohn
LONDON, Dec 11 Cajoled by developed world
governments and shocked by disasters such as the Bangladesh
factory collapse, investors in emerging market companies are
looking more closely at environmental, social or governance
issues before they buy.
Once the preserve of religious and ethically minded funds
and the development finance arms of major economies, these ESG
themes have moved into the mainstream.
Almost all emerging fund managers in a survey by UK
development finance arm CDC to be published this week consider
ESG to be integral to their investment strategy, and in many
deals they regard it as a "fact of life".
It is a sharp contrast to a few years ago, when emerging
market investors saw sustainable strategies as an irritant
imposed by worthy multilateral lenders, or "the dead hand of
eco-fascism", according to CDC's ESG director Mark Eckstein.
The global financial crisis showed that companies needed to
have strong governance to be financially sustainable.
And disasters such as the fatal Rana Plaza garment factory
collapse in Bangladesh this year illustrate the importance of
social considerations such as health and safety procedures.
"We are beginning to see questions from investors such as
'Is this company going to be in business in five years' time?',"
"There is a step up in investors' sophistication - they are
taking ESG seriously because it is an issue for them."
CDC's own investments include Halonix, an Indian firm that
makes halogen bulbs for cars, and a steel plant in Kenya with a
strong health and safety policy.
Sustainable investing has mushroomed. Such assets under
management in Europe jumped to over $8 trillion in 2010 from
next to nothing in 2005, according to HSBC, and total about $3
trillion in the United States.
But the strategy is seen as particularly likely to reap
returns in emerging stocks - even though some market
participants remain unsure of the consistency of returns.
"Especially in emerging markets, governance matters," said
Gary Greenberg, head of global emerging markets at Hermes.
"We are past the point when you can hide the pollution or
Hermes runs an emerging equity fund for U.S. ethical
investment fund Calvert Investments. The fund has seen an 11.6
percent return this year before sales charges, compared with a
4.7 percent fall in the MSCI emerging stocks index.
Investing in a way that removes ESG risks could boost
returns in an emerging equity portfolio by up to 50 basis
points, according to a 2011 study by Allianz Global Investors,
with emerging equity the asset class most likely to benefit.
But definitions of the stocks most suitable to invest in can
be muddled, and reliable outperformance hard to prove.
"I think it's random and we have been doing it for 25
years," said Brian Langstraat, CEO of fund manager Parametric,
which constructs portfolios for clients and has an emerging
market focus. He said investors are "aligning their investment
to their values, not because they are going to be paid".
Starbucks is an example of the potential pitfalls.
Should the U.S. coffee shop chain be among listed companies
in a sustainable equity portfolio, because of its work with fair
trade coffee farmers?
Or should it be blacklisted, because of the perceived
detrimental impact which the group's 20,000 shops worldwide have
on local businesses, or accusations it did not pay enough tax in
past years on its UK business?
Following widespread criticism from politicians and the
picketing of stores, Starbucks said it would pay or pre-pay
around 10 million pounds a year in taxes in 2013 and 2014.
Investors may hold a variety of views on Starbucks, showing
the difficulties of identifying an appropriate investment.
Contradictory requirements from investors are among the
biggest hurdles to employing an ESG strategy in private equity,
according to the CDC survey.
In a history which dates back to Quaker investments of the
16th century, sustainable investing has gone through a number of
guises. The number of different terms used to describe it tends
to add to the definition confusion.
Investors have moved on from straightforward ethical
investing, which involves kicking out "sin stocks" such as
drugs, weapons, pornography or gambling, as represented in the
iconoclastic Vice Fund, to positive discrimination.
Fund managers controlling assets totalling $34 trillion have
signed up to abide by the United Nations' Principles of
Responsible Investing (PRI) launched less than a decade ago.
"People tend to dismiss some of the issues as touchy-feely
and nice to have, that's not what the research shows," said
Fiona Reynolds, managing director of UN PRI.
UN PRI highlights a 2010 study of 114 of the largest Chinese
listed companies. Those underperforming socially had lower stock
performance than companies with good ESG practices.
BAD TO GOOD?
Similarly, a survey last year by Deutsche Bank of more than
100 academic studies showed that globally, firms with high
ratings for corporate social responsibility and ESG factors had
a lower cost of capital.
"In effect they are lower risk," Deutsche said.
But the chances of making money out of the strategy are less
clear cut. The Deutsche survey also said that 88 percent of
studies of fund returns showed neutral or mixed results, and
that funds with a socially responsible badge "have struggled to
capture outperformance ... but they have, at least, not lost
money in the attempt".
But if being good does not always pay, maybe being bad does
- the Vice Fund, run by USA Mutuals, has matched the glittering
performance of the S&P 500 this year with a 26 percent
gain, outstripping a 22 percent rally in the Ave Maria Catholic
Private equity funds in emerging markets complain that the
focus on ESG stops them from buying into "bad" companies and
cleaning them up, potentially a lucrative move.
Good practices can also be expensive, such as providing
low-paid employees with health insurance.
"Some of those principles make you uncompetitive," said one
private equity fund manager, adding that ESG investing was not
really necessary to help the developing world.
"If you're putting money in emerging markets, you're making
a positive impact."
(Additional reporting by Shadi Bushra, Julia Fioretti and
Sujata Rao; Editing by Alison Williams)