How have you seen the regulatory and economic environment evolve in the past three years?
We would say there are three distinct periods. The first was from the spring of 2020 to the beginning of 2021 with the rerating of renewable and battery names due to changes in regulations and technology deployment. The second phase, till the second half of 2022, was when the growth stocks that had driven the rerating retreated as expectations and valuations had become excessive, China entered a bear market on crackdowns, and there was a global correction. During that time sectors with cheaper valuations, like education, microcredit, and financials, did well (the latter was also helped by the rise in interest rates). In the third stage, markets have rebounded and, while the inflation/recession debate is ongoing, it seems equity investors have learned to manage the higher volatility. Many of the growth names that were overly expensive back in February 2021 are now at very reasonable multiples.
As for regulation, it has played a role almost everywhere and there have been improvements. The last three years have seen the EU’s Green New Deal (renewable energy push) and Farm to Fork strategy (plan to reduce the environmental impact of food production) appear in Europe and the Inflation Reduction Act (IRA) in the US. Asian economies have started setting net-zero climate targets and some sector-specific norms, and China is encouraging the electric vehicle market. In most cases these regulatory developments have been positive for asset managers, but not all. For example, ESG regulating has become a controversial issue in the US and hence a headache for asset managers there. In Europe, the expanding reach and influence of the Sustainable Finance Disclosure Regulation (SFDR), while its categories can help many clients launch products, it has also generated additional work for asset managers.
This is your first impact investing strategy. How have you evolved your own additionality?
We started with the conviction that calling ourselves “impact” was mainly about the “purity” of our portfolio, meaning that the degree of alignment with the United Nations Sustainable Development Goals was the most important factor in our mind. Over time, we have evolved to give more importance to the work we do as active shareholders. This includes adopting a constructive but critical stance on certain resolutions we are asked to vote upon and engaging in the context of our Impact Engagement Framework or in a targeted way.
Three years after launch, we are still interested in finding companies with a high score in our proprietary impact assessment system, but we now see a trade-off with investing in companies which we would hope to influence over time, even if their current score is lower*. This conviction has evolved for two reasons, one practical and one more related to our long-term ambitions.
First, in practical terms, over the last three years we have seen the impact we can have on certain companies. It does not always work, and it is rarely us alone, as many other shareholders express their own concerns about companies. But in a certain number of cases, we have seen companies take significant steps in what we see as a positive direction and we have played a small but gratifying role in facilitating these changes. More specifically, this has happened through the many in-depth discussions we have been having on financed emissions with the financial companies in our portfolio, the advice we have given management teams about how to integrate sustainability into their incentive programs, and our participation in various collective engagement campaigns, such as the CDP Non-Disclosure Campaign.
Second, we have thought long and hard about what it means to have “impact” in our name, and it cannot be limited to the impact of the companies we invest in. If it were, we would be limited to investing in a small number of companies that are already 100% convinced about the importance of integrating sustainability. Clearly, we want to be more ambitious about that and help widen the pool of investments available to investors like us.
How does engagement differ for you compared with your developed markets colleagues?
Engagement is one of the areas where we no longer have boundaries between EM and DM in our Positive Impact team. Team members engage with portfolio companies both on systemic (Impact Engagement Framework) and ad hoc (Targeted Engagement) bases, irrespective of their direct portfolio responsibilities. This gives each team member a wide perspective to observe various levels of engagement across companies in a variety of countries and sectors.
In general, within EM, the level and quality of engagement is in a wider range than DM. We see companies that are as enthusiastic as in DM, but we also come across reticence that is unlikely to be seen in DM. Our main opportunity is to be able to share best practice with our EM companies to encourage them towards better sustainability practices. In a minority of cases, EM companies may have world-class best practice which we can also share with DM companies. The cases in EM where companies have been less responsive than we would have liked have forced us to think of ways and policies to escalate our engagement efforts, which, in a very small number of cases, has not yielded results and led to divestment.
In both geographies, we are encouraged by an improvement in companies’ willingness to respond to our engagement efforts and voting intentions with good-quality input backed by data and better disclosure.
What is your outlook for impact investing in emerging markets? Is now a good time to invest?
In general, EM countries have coped well with the transition from a low-inflation, zero-interest-rate environment to sharp rate-hiking by all major central banks. In previous such switches, the steep rate rises and US dollar appreciation have caused financial crises in EM, but not this time. There may be several reasons for this, such as responsible fiscal policy, tight monetary policy, and cheap FX valuations in EM prior to the policy change.
We are pleased with this resiliency and we see several investment opportunities in equity markets, particularly for impact investing. One of our largest opportunity sets in EM is renewable energy and clean mobility (EV and battery value chain, bikes/e-bikes). Many companies in EM have emerged as global leaders in these areas while leading the cost revolution that has made these solutions competitive without subsidies.
Increasing reliance on EM has led to some worries in DM which are now trying to encourage the development of local industries through major policy initiatives such as the IRA in the US. This in turn has led to some worries for EM leaders and caused underperformance among some high-quality names. We believe this offers a good opportunity to invest in this area, as we are seeing attractive valuations similar to levels when the fund was launched three years ago. We understand that the development of local industries in the US and the EU may mean that market shares of EM companies may come down from their current unsustainably high levels. However, the structural growth trend in demand both in EM and DM over the coming decades is likely to continue to drive healthy earnings growth which could benefit those investing at current valuations.
*Those companies still need to meet the minimum IMAP score of 12/20