Many sophisticated investors use “developed” and “emerging” as classifiers of risks related to country and regional indexes. Yet, both developed and emerging markets have a mix of transparency and ESG (environmental, social, governance) performance that are also additional factors of analyzing future risk for intelligent investors. Adding these classifications to the countries, regions and corporations that equity investors evaluate can strengthen portfolio resiliency and financial performance potential.
As transparency and data comparability across different equity markets increases, investors have the unique opportunity to use different impact, sustainability and ESG (environmental, social, governance) strategies to inform their choice of investments within a market or choose which markets to invest in. These strategies range from using ESG-tilted indexes as a means for investing in different countries’ equity markets to using widely available overall ESG metrics of an industry, sector or geographical region as an indicator of risk.
Developed Markets Performance on ESG
European countries have consistently outscored the rest of the world on transparency and performance on different ESG metrics. Overlaying ESG performance (in this case, using HIP Ratings) on 38 MSCI country indexes resulted in European countries ranking at the top in all aspects of ESG performance as well as transparency. Studies of corporations across countries on corporate social performance as well as ESG risks also corroborate the leadership of Europe, and especially Scandinavian countries, in this arena. The transparency-performance matrix using HIP Investor’s data allows a unique comparison between the trade-off in these two arenas and areas of future improvement.
Transparency looks beyond simple coverage levels to assess the level of detail of reporting on impact, sustainability and ESG metrics by the firms within each country index, and performance assesses the relative position of the index in terms of reported ESG data. The comparison in the matrix below shows that within developed markets, higher ESG performance is strongly linked with the transparency, level of disclosure and ESG reporting by individual companies. Australia and Norway are the only exceptions where above-average performance in one category did not translate into the same for the other.
Emerging Markets performance on ESG
The trade-off between transparency and performance is not similar for emerging markets where it is more common to have an imbalance between the two. On the basis of comparative HIP Scores, South Africa and Brazil showed promising results compared to other emerging markets, indicating a positive influence of ESG reporting regulations as well as an increased focus on ESG performance. Israel, India and Russia benefited from comparatively higher levels of transparency on ESG metrics but showed poor performance on the reported numbers. Mexico, Chile, Colombia and South Korea’s scores were adversely affected by low levels of transparency across the metrics, despite promising performance on the incomplete picture of ESG performance.
Thailand, Malaysia, Indonesia and the Philippines in Asia, as well as Russia and Turkey in Europe performed poorly on both transparency and performance captured by HIP Scores. There is a need to push public corporations, stock exchanges, investors and governments in these countries towards not only greater transparency in reporting on ESG issues, but also to work on improving their performance.
ESG Indexes and Ratings Providers Help Investors
Msci, Inc. (MSCI) , for instance, provides its customers more than 200 ESG-themed indexes for different strategies, asset classes and global industrial sectors as a benchmarking and investment tool. These investment strategies include negative screens for certain industries or low performers on ESG factors, as well as using ESG performance as a custom weighting tool. Verisk Analytics, on the other hand, assesses country-level ESG and political risk to guide investors in 197 countries, especially around governance issues. Investors can modify their due diligence process based on different risk levels and/or incorporate ESG performance of the country as a risk metric in their international asset valuation models.
EIRIS provides coverage on 3,500 companies around the world, incorporating more than 110 ESG metrics in its analysis. Through different platforms and services, EIRIS quantifies ESG performance and risks for companies and countries across the world, enabling responsible investors to incorporate ESG metrics in their valuation models across asset classes, sectors and global markets. HIP Investor uses a unique methodology to rate 4,500 global equities (and 4,000 muni bonds) on how their ESG performance links to future risks, value creation and possible surprises for investors. HIP’s five ESG pillars of Health, Wealth, Earth, Equality and Trust capture the corporation’s impact results, covering employees, customers, local communities, shareholders and the world at large.
Have you assessed your investment portfolio for transparency and ESG performance? A deeper dive of your investments by country, region and corporation can help manage your exposure to future surprises and possible opportunities for enhanced financial performance. Intelligent investors are always assessing new factors to evaluate – including ESG and transparency.
How do you segment your portfolio for risk? Share your commentary and suggestions in the comments section below, and come back next week to read part four in this four-part series. You can also find Part 1 here and Part 2 here.
By Hummayun Javed and R. Paul Herman
Hummayun Javed is an impact investment analyst, with a Masters in Global Policy Studies from the LBJ School at the University of Texas at Austin; R. Paul Herman is CEO, CIO and an investment adviser representative (Series 65) of HIP Investor Inc. and CEO of investment ratings firm HIP Investor Ratings LLC (More info at http://www.HIPinvestor.com)
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