- COVID-19 has exposed how wide the gap is between the various emerging markets.
- The pandemic has worsened an already bad income distribution problem in many EM countries.
- In the post-COVID-19 world, we divide the universe in three categories of sector: those profoundly and negatively impacted by the pandemic; those that benefited from an acceleration in growth due to the pandemic; those for which the pandemic was a mere bump in the road and where the growth outlook remained intact.
- Our mapping of the SDGs allows us to invest accordingly and thus to benefit from the drivers of the different sectors.
A pandemic, a stress test and the future
The dual mandate of impact investing* was immediately tested with the launch of our positive impact emerging portfolio in May 2020, as it coincided with the peak of uncertainty related to the COVID-19 pandemic. The main challenge was to balance our goal of investing in impactful companies while making sure that our investors’ capital was protected during a very volatile period. We believe we achieved this goal and the portfolio successfully passed the very challenging test of balancing impact and financial returns at a very early stage of its life.
As we finally begin to see the light at the end of the COVID-19 tunnel, we are starting to think about the challenges ahead.
According to the World Bank, the crisis has led to an increase of more than 20% in the number of people living in extreme poverty: for the first time in a generation, the quest to end poverty has suffered a setback.
In many places, the pandemic has negated recent progress made for gender equality. There have also been warnings that the fall in carbon emissions that it has produced will only be a blip in a long-term trend if we do not put the right policies and solutions in place. These are daunting problems that the private sector alone cannot tackle, but we hope the companies in our portfolio will play their part and be the “fixers”** of tomorrow.
In this paper, we will review how different emerging markets went through the crisis and look at the future for different sectors in terms of investments in a post-COVID-19 world.
* Intention of investments is to generate a measurable social or environmental impact alongside a financial return.
** Companies with products and/or services that deliver positive social and environmental impacts.
Find out how different emerging markets went through the COVID-19 crisis in the full version of our white paper.
The impact emerging equity investment universe in a post-COVID-19 world
When we think about the state of our investment universe in a post-COVID-19 world, we divide our investment universe into three parts. First, the sectors that were profoundly and negatively impacted by the pandemic, and which will have to rebuild their profitability over the medium term. Second, the sectors that benefited from an acceleration in growth due to the pandemic. Third, the ones for which the pandemic was a bump in the road and that have seen their growth outlook remain intact.
The post-COVID-19 cyclical recovery: are we there yet?
The pandemic led to a near complete shutdown of entire sectors of the economy. Few were more negatively affected than the microcredit sector. Microentrepreneurs in medium- and low-income countries were among the economic victims of lockdowns. As the Chief Financial Officer of Gentera*** (one of the microcredit leaders in Latin America and one of our portfolio holdings) put it at the beginning of this year, “…the willingness to pay back their loans was still there, but many had lost their business.”
This created a tense situation for the industry. The asset quality deteriorated globally. We saw companies restructuring the majority of their loans and the number of non-performing loans rose substantially. It was, of course, a very difficult situation, but a few things helped the companies we are invested in in the sector. First: size. The bigger players had more flexibility in terms of financing and in some cases had already made the digital investments that allowed them to move online quickly. This was an opportunity to gain market share. Second, the demand for microcredit paper remained strong despite the severity of the crisis, and a liquidity crisis was averted for those who could tap international markets.
It was still a very difficult year that led to a collapse in the sector’s profitability. The share prices have followed that movement and have started to recover but are still well below their pre-crisis levels. We see this as a cyclical opportunity. As and when each market moves out of this crisis, we expect microcredit to recover strongly. Microcredit is not the catch-all solution that it was once perceived to be, but it is a valuable financial tool that provides flexibility to microentrepreneurs in many low- and middle-income countries. If it can continue to do that, volumes should go up substantially over this cycle.
Similarly, the education sector has suffered during the crisis. Enrolments of new students have gone down in many markets. Prospective students are right to be apprehensive when, in many cases, the pandemic prevents them from having an on-campus learning experience and negatively impacts their ability to find a job at the end of their studies. In addition to this, many higher education providers have had to cut prices, either to reflect changes made to the programmes they were offering, or, as we saw in Brazil, because they were legally obliged to do so.
That said, the long-term outlook for demand is unchanged. Short-term enrolments might be affected by COVID-19, but the rationale in emerging markets to get a higher education is well known and not something that has changed over the last twelve months.
The proportion of the population that progresses to tertiary education (university or vocational qualifications) hovers between 10% and 30% in many emerging market countries but is well above 40% in many developed economies.
Some of the markets we invest in, particularly in Latin America, have the largest salary premiums in the world for young university graduates, meaning the incentive is not going away.
*** Gentera was originally an NGO but became a listed company in 2007. The company is a pioneer of microlending in Mexico, with a focus on giving women the financial tools they need to establish and grow their own businesses. We talked to the company’s CFO, Mario Ignacio Langarica Avila, about the transition of the business to a for-profit group and the unique challenges presented by COVID-19. This interview is available in our Impact Report 2020.
Energy transition: 2030 and beyond. A continuation of the transition agenda
There is no direct link between COVID-19 and energy transition, but the pandemic seems to have acted as a catalyst. Many of the recovery plans announced around the world in the spring of 2020 had a higher-than-expected “green” content, and that triggered reratings for many electric vehicle and clean energy providers.
Towards the end of the year, we saw China, followed by Japan and South Korea, announcing for carbon neutrality targets for their economies. This was followed in 2021 by the return of the US to the climate change negotiating table with a much more ambitious 2030 target and a willingness to assume its historic leadership on the issues. In between, many other countries have revealed improved carbon emission targets. All countries will gather in Glasgow on 1 November for COP26 and, if the current momentum is sustained, an overwhelming majority of the heaviest polluters will attend with recently revised and more ambitious targets.
As a result of this, regulations have become more favourable for stocks that enable energy transition and because many long-term commitments still need to become reality, we expect the trend of favourable regulatory decisions to continue. The price of carbon in the European Union has just reached EUR 50 per tonne for the first time, and that will in turn push even more companies to review their plans for the future. In this context, we see the rise of electric vehicles in the transport mix as a near-certainty, and current expectations for renewable energy could even be improved.
This does not mean that we would be happy to be exposed to these trends at any price, since some stocks’ valuations might already reflect recent improvements, but the underlying trends are likely to be with us for many years, and we should not see this as a passing fad. For instance, European carmakers will have to live with emissions targets for their overall fleets, which will give them no choice but to invest in electric vehicles and battery plants in the foreseeable future. Some of the companies we own in the battery value chain are certain to benefit from increased volumes. Similarly, China’s commitment to have its emissions peak by 2030 cannot be achieved without an increased share of renewables.
The best of the rest
While COVID-19 has modified many sectors’ outlooks for the medium-term, it has not changed everything.
The world saw recent progress wiped out by COVID-19. For instance, as mentioned in the introduction, the World Bank estimates that poverty has increased globally for the first time in twenty years, with 1.4% of the world’s population falling back under the poverty line as a result of the crisis. Other areas will be relatively less affected, which is something we have seen in our portfolio.
In the healthcare sector, we invest in companies that have raised their R&D spending to better treat non-communicable diseases or offer more affordable products to low- and middle-income countries. One or our portfolio companies has designed the first ever child-friendly HIV treatment, which allows children born with the disease to receive better care. This might seem less urgent than some COVID-19-related problems the world is currently facing, but this is important to those people affected, and reinforces this company’s market position.
Similarly, some of the investments made in infrastructure are built to last much longer than the current cycle. In water utilities, some companies in Latin America have been facing historic droughts and have long since started to make the investments that would allow them to continue to face that situation. In industrial PCs, we saw demand pause in 2020, but pick back up towards the end of the year as companies seem to be even more convinced of the importance of digitising their businesses. In waste management, the demand for better recycling solutions has continued unabated. All of these aspects fall into the category of “boring but important”. Those businesses will, we hope, continue to benefit from long-term trends that have not been affected by the recent crisis.
How to capture these different trends in emerging markets
As we focus on impact investing, we believe many opportunities will arise in sectors that can benefit from the multi-year investment cycles that result from the UN SDGs. As seen earlier, this is a broad universe which includes a variety of company profiles, from the ones which should continue to benefit from elevated growth rates (e.g. renewable energy) to sectors such as education and financial inclusion businesses (e.g. mobile payments, microcredit and SME financing) where many companies which suffered substantially during the pandemic could do very well in the next few years.
To capture these different opportunities, a global approach is necessary. We use the UN SDGs as a roadmap. Effectively, we have benefited from our collaboration with the Investment Leaders Group (ILG, facilitated by the Cambridge Institute for Sustainability Leadership) to address the 17 UN Sustainable Development Goals through six themes: climate stability, healthy ecosystems, sustainable communities, basic needs, health & wellbeing, and inclusive & fair economies.
Each theme represents a number of SDGs, sub-goals and industrial verticals. Each vertical also has its own dedicated objective and associated target KPI. Ultimately the process flows to each investment and a KPI which we feel most closely measures the fulfilment of our overall intentions whilst being suitably precise in reflecting the specific activity of a business. The aim is always for these KPIs to be derived directly from the company, but in the absence of this, there are instances where we use industry proxies. This allows for real efficiency in the investment approach as the hunt for ideas is led from these areas, rather than the more traditional “GICS” sector or geographical breakdowns.
This approach allows our Impact team to remain committed to identifying, researching and engaging with the world’s best fixer companies across the full spectrum of the UN SDGs and to invest in tomorrow’s technological champions in a wide array of applications to fully meet the impact investing challenge, i.e. to generate investment returns by focusing on a more sustainable planet.