Emerging markets need more funding to close developmental gaps and to adapt to a changing climate, and a better flow of information and greater accuracy of information can help to increase the flow of investment funding.
Recent United Nations estimations indicate that emerging markets will need about $5-trillion to $7-trillion a year in investments to address developmental gaps, impact investing advisory firm Courageous Capital Advisors president and CEO Laurie Spengler said this week.
This is a “scary” amount, but a comparatively small percentage of yearly global investment flows of $50-trillion to $80-trillion, and is achievable, added fund management company M&G Investments emerging markets fund manager Greg Smith during a webinar hosted by research and consulting firm Intellidex.
For emerging markets to achieve their goals and make developmental progress, as well as to ensure sufficient climate adaptation and mitigation, they need a flow of capital, he said.
Further, there is increasing emphasis placed on environmental, social and governance (ESG) metrics and on impact investing, with many specialist ESG managers and emerging markets and frontier market managers, who responded to a study by financial research and consulting firm Intellidex, saying ESG processes are factored into decision-making frameworks, Intellidex chairperson Stuart Theobald pointed out.
“Many of the respondents use in-house models to weigh and set thresholds for emerging markets and issuers. These investment metrics are increasingly being applied and there is a strong sense of growth in the use of ESG decision-making frameworks,” he said.
An additional significant concern was that emerging and frontier markets, on any investment scoring system, tracked poorly, and this is an important aspect that is difficult for developing countries to deal with, he added.
Further, while there are many nuances to the way this functions in practice, there are tensions between environmental and social investment demands, he said.
Environmental data has been developed faster and developed market-focused emerging market strategies tend to have environmental considerations as dominant considerations.
However, emerging markets and frontier markets may need more social investments, and there are risks that domestic market perceptions may negatively view investments as more concerned about environmental than social needs, which may delegitimise foreign investments in a country, Theobald said.
“In the social space, education, healthcare and sanitation, for example, are more difficult to measure and quantify, making it more difficult to invest in such projects,” he said.
There is a need for social investments in emerging markets, and markets and investment data providers have tried to solve the challenge of limited data, highlighted Theobald.
“The sense we gained from respondents to the study is that there are generally poor data sources on emerging markets and no indices to bias capital to deliver enhancements on United Nations Sustainable Development Goals (SDGs) or other impact investing measures,” he said.
It is difficult for funds to prove to clients that their investments are generating positive impacts in line with the investment mandate, and there is a need to ensure a flow of information to support a flow of capital, Smith added.
If companies do not conduct ESG investing properly, they are letting down their clients and could be fined by regulators, he added.
Investments in emerging markets need to take a medium- and long-term view, but fund managers can also potentially invest in countries that are making progress towards various developmental and environmental goals, Smith said.
“Smaller countries are limited more by their ability to absorb funding and use it well than the availability of money. Better articulation of what the money is being borrowed or raised for, and providing a clearer view on the use of proceeds and defining what they are doing with the investments better, is needed,” he advised.
The enormity of the task of enabling investments into emerging and frontier markets is clear, but there has been progress over the past few years, Smith said.
“There are new green, SDG and social bonds and, as the asset class grows, it will be easier for funds to say they are buying a particular asset as it fits their ESG agenda,” he noted.
A better flow of information about emerging markets will also help marginal investors to participate, he said.
There is a data gap in ESG, and most available information is backwards-looking while the opportunities available in emerging markets require bottom-up analyses, noted investment company Abrdn investment director and ESG equities head Sarah Norris.
“In terms of Abrdn’s strategy, we prioritise unmet needs and use the World Bank database and other international agencies’ databases. Where various needs are below the global average, we look for companies providing solutions to these unmet needs. This helps us to hone in on demand opportunities,” she said.
Meanwhile, development finance institutions (DFIs) have, and are playing, a large role in supporting ESG investments into emerging markets, said Smith.
“They are a force for good and a global public good from the perspective of providing data, which is one of the ways we monitor ESG trends, with DFIs providing macroeconomic, social and governance data flows on a regular basis. Our first port of call is often DFI reports on a country,” he said.
In terms of concessional finance and emergency finance, the role of DFIs has been highlighted, such as the role of the International Monetary Fund during the Covid-19 pandemic impacted period in providing rapid financing, Smith added.
“The way they work is important and they can play a role as catalysts for investing in a particular climate adaptation project, for example. Further, as they carry out due diligence processes and do assess the impact of projects, this helps to get marginal investors involved,” he said.
The challenge is how to get such effects to scale. Key to this is to determine how the money can be absorbed and whether it will be spent well by a country, as further investment rounds can provide greater funding, he said.
“The problem is to build an ESG framework that is data-driven. If we look at changes in governance perception rankings, for example, this is not high-frequency data. But we have to explain why we are investing and a quantitative approach can help to verify and demonstrate that investments are helping a country to reach its SDGs,” Smith said.