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  • Sustainable Investing Across Emerging MarketsApril 2012

    Lloyd Kurtz, CFASenior Portfolio Manager

    Nelson Capital Management

    Lisa Leff Cooper, CFASenior Portfolio Manager

    Nelson Capital Management

    Alison ShimadaAssociate Portfolio ManagerWells Capital Management

    1For a full discussion of UNPRI, please see the appendix2Kurtz and DiBartolomeo, The Long-Term Performance of a Social Investment Universe, Journal of Investing, Fall 20113The amount of carbon dioxide or other carbon compounds emitted into the atmosphere by the activities of an individual, company, country, etc.

    Executive Summary

    Once considered an investment strategy that catered to a few socially concerned investors, sustainable investing is now an important discipline for mainstream investors, investment managers, and consultants. Sustainable investing is the concept that environ-mental, social, and governance (ESG) factors impact long-term financial performance. An important catalyst for the evolution of sustainable investing has been the overwhelming growth in support for the United Nations Principles for Responsible Investing (UNPRI) which was launched in 2006 as a framework for asset owners, asset managers, and service providers to demonstrate their commitment to sustainable investing.1

    Critical to the groundswell of support for sustainable investing has been the academic work to dispel preconceptions that integrat-ing ESG factors into investment processes is detrimental to performance. The debate has centered on the intuitive assumption that limiting the opportunity set of investable companies to only those meeting ESG criteria would lead to a less diversified portfolio with lower returns compared to the broader universe. Research studies have not been unanimous in their conclusions but have introduced enough positive support to further the fiduciary merits of ESGlong-term investment performance is not hindered2 in the pursuit of success on environmental, social, and corporate governance issues.

    Today, sustainable investing, with its focus on identifying strong corporate performance with regards to the environment, social equity, and corporate governance, provides a unique and important set of tools for emerging markets investors. For example, countries like Brazil and China are placing an emphasis on environmental protection and innovation. Hydropower generates 70 percent of the power in Brazil contributing to a low carbon footprint,3 while China is struggling with high levels of air pollution. Social issues are important in South Africa and India as the governments of both countries work to bring basic services to all of the residents of these countries. Meanwhile, the South Korean government has mandated certain levels of energy efficiency which has led to South Korean companies becoming global leaders in exporting this technology.

    This paper will explore how each of these countries is rising to meet these challenges and how a skillful investment approach that focuses on ESG can be a great opportunity in emerging market investing.

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    4UNPRI Report on Progress, 20105SRI as an Asset Class, Bank of America Merrill Lynch, August 12, 20116eVestment 12/31/117Mercers ESG ratings update 5,000 and counting Mercer Consulting, 2012

    Growth of Sustainable InvestingOne major impact of the UNPRI has been to mainstream the concept of sustainable investing rather than consider it as just a specialized asset class. Indeed, over 70 percent of the asset managers signing the UNPRI consider themselves mainstream managers with the balance considering themselves dedicated socially responsible investing (SRI) or ESG specialist managers.4 Therefore, while the support for sustainable investing has the clout of $30 trillion in assets owned/managed/advised, estimated actual AUM invested related to sustainability is about 7 percent across asset classes (up from 4 percent in 2008).5 Globally, the popularity of sustainable investing has some notable regional differences. Interest is highest among European asset owners and investment managers, followed by Sub-Saharan Africa and North America, as seen in Table 1 on page 3.

    There is little doubt that specialized sustainable investing strategies are poised for further growth, as new products and strategies are being developed across markets and asset classes. According to eVestment Alliancea leading third-party database for institutional asset management46 new strategies have been added to the database since the beginning of 2009 that focus on ESG investing within the global, international, and emerging markets universes, with five specifically focusing on emerging markets.6

    Mercer Investment Consulting has a dedicated practice to responsible investing and they assign ratings to the strategies in their database based on how well the manager incorporates ESG into the investment strategy. Managers are categorized into four groupsESG1 (the highest rating) to ESG4 (the lowest rating). Mercer currently rates 466 strategies, or 9 percent, with the two highest ratings.7 This would be indicative of how many strategies broadly have an ESG focusthe combination of mainstream strategies not designating them specifically as ESG specialists and those that are designating themselves as ESG specialists.

    The ESG Investment Proposition for Emerging MarketsUntil recently, ESG information on emerging markets com-panies was difficult, if not impossible, to obtain, and many young and fast-growing emerging markets companies were more focused on rapid growth than management quality and corporate responsibility. However, as emerging markets have been increasingly challenged by resource constraints, social unrest, global standards, and demands for corporate account-ability, companies that understand the challenges and evolve will differentiate themselves from those that do not. This differentiation is potentially an important factor in evaluating earnings growth potential over both the short and long term. In particular, emerging markets companies providing innovative solutions to environmental and social challenges may present particularly attractive investment opportunities.

    In the emerging markets, population growth and economic development are creating both challenges and large-scale opportunities related to the environment and social equity. Threats to the ecosystem, social advancement, and a trustworthy business environment now also threaten to limit the potential for future economic growth. At the same time, companies within emerging markets have the potential to lead the world in developing lower-cost, innovative solutions to the biggest social and environmental problems. Just as emerging markets have become a key driver of global growth, they are quickly becoming the focal point for sustainable economic development.

    ESG Themes Across Emerging MarketsSome of the worlds leading sustainability solutions and ESG practices are now coming from developing countries, creating promising opportunities for investors. Three of the more developed emerging markets economiesBrazil, South Africa, and South Koreaare recognized in one or more ways as global sustainability leaders, and all three countries have introduced sustainable investment indexes setting high stan-dards for corporate ESG practices. China and India are earlier on the evolutionary scale of sustainability, but share enormous

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    opportunities and vulnerabilities related to sustainable economic development. The following discussion takes a closer look at some of the most important sustainability-related opportunities and risks across these five key emerging markets from both a corporate and government perspective.

    Brazil Valuing Its Natural ResourcesBrazil is uniquely blessed with many natural resourcesdense forests rich with biodiversity, substantial oil and mineral deposits, and some of the worlds largest and most pristine rivers, including the Amazon. But as the worlds fifth-most populous country, Brazil also faces major environmental challenges related to growth and developmentdeforestation, air and water pollution, and an expanding carbon footprint. The goals of development and conservation are often at odds with each other, but Brazil has unique opportunities to both protect and leverage its rich natural resources.

    As an example, Brazil generates more than 70 percent of its elec-tricity from hydropower, contributing to the countrys low carbon profile. Brazil also generates a significant and growing portion of its energy needs with biodiesel, in particular sugar cane ethanol, which is a relatively efficient source of energy. In addition, Brazil is a global leader in developing high-speed railways and other forms of mass transit. With this energy mix, Brazil is on target to meet its greenhouse gas emission reduction goals for 2020.

    Brazils government has established regulations and policies to protect the countrys environment as its economy rapidly develops. Brazils National Plan for Climate Change calls for

    conserving and reclaiming national ecosystems; expanding legally protected natural areas; slowing the rate of Amazon deforestation (with a target set in 2009 for reductions of 80 percent by 2020); improving energy efficiency in construction, farming, and industry; and enhancing the production of sugar cane ethanol. Similarly, Brazil has set other major initiatives around improved sanitation, more efficient transportation, and better water management.

    Against this backdrop, environmental management at Brazil-ian corporations has become, as a whole, more advanced than in many developed countries. The Dow Jones Sustainability Index, which strives to include best-in-class sustainability leaders from around the world, now includes seven Brazilian companies (Australia is the only Southern Hem


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