An Evolving EM Strategy for a Changing World

    Investing in developing countries is perhaps the most intuitive approach to addressing the Sustainable Development Goals (SDGs). However, it is not always easy to measure and report actual impact and actual performance has not always met expectations. 

    These considerations are particularly prominent for Premier Miton, a UK-based boutique investment manager, which recently hired highly experienced emerging market (EM) portfolio managers Fiona Manning and William Scholes to set up a new EM strategy that aims to deliver long term capital growth through focusing on companies aligned with sustainable long term growth themes.

    Surveying the landscape of sustainable investments in EMs, Manning highlights the lessons learned from recent market turmoil, the pitfalls of frontier markets, the implications of Brexit for sustainable and impact fund classifications and the evolution of sustainability data and reporting for EM strategies.

    A More Robust and Impactful Investment Approach

    One of the appeals of setting up a new fund at Premier Miton was the opportunity to start with a blank sheet of paper and refine the investment approach. “When we started planning the strategy we had some time to think about what it was we were trying to achieve and what it is that drives company value when managing a sustainable fund. The industry didn’t really acknowledge how much unintended factor risk was driving fund performance between 2018 and 2021. In my experience, it was very difficult to avoid growth stocks,” Manning explains. 

    “With markets being driven by growth and momentum, we had a two-year period when funds outperformed, which drove a lot of investor inflows into sustainable strategies. As the market inevitably shifted away from that trend it was very painful for sustainable managers. We spent a significant amount of time considering how we could moderate the risk of these positions and how to best manage the portfolio. This experience was very much in the back of our minds when we were building the new strategy at Premier Miton,” she continues. 

    “We wanted a strategy that would be more robust in a wider range of market environments, financially speaking. The approach we have taken focuses on three key questions we consider when analysing every company in the portfolio: First, ‘Is what the company does sustainable?’ Second, ‘Is how they do it sustainable?’ Lastly, ‘Can they generate a sustainable financial return by engaging in that business?’,” Manning explains.

    Fiona Manning, Portfolio Manager, Emerging Markets
    Premier Miton

    A Three-Pronged Approach

    The first question allows Manning and Scholes to identify areas where there is a clear addressable market, sector or product that has been underserved or underinvested and that is aligned with the UN Sustainable Development Goals (SDGs). “The SDGs have the advantage of removing any guess work regarding whether or not an activity can be considered sustainable and provides an external validation for the relevance of a company. From an asset management perspective, the SDGs also work as a map of demand for specific activities that are perceived to be underserved. Underlying this approach is a five stage theory of change process which also considers hurdles to the achievement of the SDGs,” Manning notes.

    The second question allows the EM strategy to focus on ESG risk. “There has been a lot of debate over the years as to whether ESG has explanatory power in terms of stock price performance. However, there appears to be an emerging consensus that companies that manage ESG risks better can outperform those that do not. The market seems to value those businesses at a higher premium to other business. Moreover, their return profile is more consistent over time. For a company to be truly sustainable it needs to have a ‘social license to operate’. It needs to think about whether it is doing right by all of the stakeholders in its ecosystem, be it employees, shareholders, consumers and local communities. If everyone’s needs are acknowledged and addressed, we are able to assess whether everyone is pulling their weight in the right direction, which will lead them to be more successful in the longer term. Those businesses will enjoy a premium and investing in them allows us to tap into their ‘alpha’,” she adds.

    The third question was particularly relevant in setting up the Premier Miton fund because the portfolio managers are working with different resources. “To consider whether a company generated a sustainable return, we looked at the last 20 years of EMs and their reaction to different periods of economic and stock price performance. We then back-tested the type of financial metrics of companies that showed the greatest explanatory power in terms of share price performance and long term financial returns. This allowed us to identify what we call ‘financial sustainable companies’: cash-flow generative businesses that are reinvesting in their product development, that embrace innovation and use it to stay close to their customers and meet their needs,” Manning explains.

    Premier Miton’s EM Strategy

    Weaving these elements together is what shapes the portfolio. “The strategy has dual goals of providing financial outperformance and delivering environmental and social outcomes through the companies we invest in. This is the type of approach that might be adopted by an EU SFDR Article 9 fund. The strategy’s investment universe is the MSCI Emerging Markets and the MSCI Frontier Markets. It’s an all cap strategy so small caps are included in this universe. This leaves us with a starting point of 4,000 names,” Manning explains.

    “After applying a financial sustainability filter and sectoral screens we are left with a concentrated portfolio of 45 publicly traded companies, mainly focusing on financial inclusion, education, health and well-being and renewable energy. The strategy is scalable in terms of size while still manageable from the perspective of engagement,” she adds.

    Although Frontier Markets (the segment below EMs in terms of institutional development) may seem like a natural target for an EM investor such as Manning, the truth seems to be more nuanced. Among other issues, the sectoral distribution of public companies in Frontier Markets is not conducive to impact investments. “We tend to find that public stock markets in frontier markets are heavily dominated by extractive fossil fuels. The banks tend to be corporate banks that don’t really target an underserved demographic such as microenterprises, entrepreneurs, SMEs or the bottom of income distribution,” Manning continues.

    Post-Brexit Regulatory Landscape – Article 9 and Impact

    While discussing the regulatory constraints on strategy, Manning highlights the impact that Brexit had on this process. “The product we offer is available as a strategy in the UK. Because of Brexit, we are not regulated by the EU, so it doesn’t come under the EU’s Sustainable Finance Disclosures Regulation (SFDR) requirements at the moment,” Manning says.

    “We fall under the UK Sustainable Disclosures Regulation (UK SDR) framework, which is not yet fully realised. Clearly, though, we are aware of the regulations in the UK and EU and the needs of European investors when they are looking to invest in sustainable strategies. We look forward to being able to discuss the strategy with such investors and explain our approach to financial returns combined with sustainable outcomes. When all the pieces fall into place, our ambition is to launch the strategy in a structure that can be distributed within the EU,” she argues.

    The strategy is also not described as an impact fund, for practical reasons related to the UK’s own  regulatory environment. “Because regulators are still devising the UK SDR framework, it is still not clear what exact approach the UK regulator will take to impact,” Manning explains.

    “The UK FCA’s initial consultation documents left us with the impression that there was going to be a requirement for strategies and funds labelled and marketed as ‘impact’ to show additionality. If this requirement was to materialise, this would mean that a fund labelled as ‘impact’ would need to provide new capital, i.e.: provide funding for projects that would not exist without that capital. Again, we will keep ourselves well informed as the regulations change, we want to be able to manage our investment strategy within the prevailing regulatory and disclosure regime and clarity on that would be helpful,” Manning continues. 

    Regulatory Convergence 

    According to Manning, the regulatory frameworks will probably lead laggards to converge towards the models adopted by leaders. “The EU’s reporting framework has only really gotten started this year, after a long preparation but it is still ahead. If the UK had gotten its framework out earlier there would have been more divergence. As it stands, the FCA has postponed its announcement by another quarter so the EU continues to lead on this issue,” she says.

    “The ambition of both regulators appear to be aligned, and as we move forward I am sure that clarity I mentioned would be welcomed by fund managers and investors, of all types,” Manning adds.

    However, the longer the process takes in the UK, the longer large fund manager houses with operations in the UK and the EU will have to go through the process of pre-contractual reporting and regular reporting according to the SFDR framework. This will allow SFDR-compliant processes to become more embedded in how portfolio managers think about their investments and how they explain their decisions to clients. In my view, the longer the UK takes to develop its own system, there is a risk of greater pressure for its framework to conform with the EU’s,” Manning argues.

    Impact Reporting in Emerging and Frontier Markets

    Data availability and reporting is also an issue for emerging markets. In order to be credibly considered an ‘impact strategy’ there is an expectation of transparency around the measurements and the reporting of the fund’s non-financial contributions. It’s become more sophisticated but it’s an aspect of EM impact investment processes that need to improve, according to Manning. 

    “Generally speaking, the disclosure of ESG data and sustainability reporting is much lower, particularly as we move into smaller caps and smaller emerging or frontier markets. Our ability to get reportable data in order to measure impact at portfolio level is much more challenging than it is for a developed market or a global impact strategy,” Manning adds. “This was another source of caution about positioning ourselves as an ‘impact strategy’ whilst being realistic about the percentage of investments that we can provide that portfolio level reporting for. We want to be crystal clear that our clients understand what we are trying to achieve and the limits of what we can deliver in terms of reporting,” Manning notes. 

    But the issue of data availability and corporate reporting is not just important for the marketing value of being able to describe the strategy as impact. Manning discusses the genuine value added by this added layer of transparency. “This data is crucial for investors like us, not because it provides the answer but because it gives us the prompt to ask the right questions regarding how the companies think about some of the ESG risk factors in their business, about the opportunities from a sustainability perspective, and how they structure their business to best manage these opportunities and risks,” she continues.

    “The goal is to report impact outcomes on a regular basis, but we think that the quality of the data will evolve over time as the quality of the reporting of the underlying corporates we invest in improves. For now we would rather err on the side of caution, lest we be accused of greenwashing,” Manning concludes.

    Filipe Albuquerque
    Filipe Albuquerque
    Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.

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