ESG factors drive higher performance in Emerging Markets

In 2016, NN Investment Partners and the European Centre for Corporate Engagement (ECCE) at Maastricht University completed a second ground-breaking study on the effects of environmental, social and governance (ESG) data on investment performance, this time on emerging markets (EM) equity. The study finds that investing in EM equities with high ESG ratings leads to better performance when adjusted for country and sector factors. The exclusion of companies with controversial ESG behaviour contributes positively to overall performance of investment portfolios.

The Materiality of ESG factors

The report, entitled ‘The Materiality of ESG factors for emerging markets equity investment decisions: academic evidence’ is the first comprehensive investigation into the performance of EM equity portfolios using ESG criteria. It found that the gains from investing in companies with higher ESG ratings are stronger in EMs than in Developed Markets while ownership structures of companies is the most important corporate governance driver.

EM companies are often assumed to give little or no consideration to the sort of sustainable practices that are increasingly considered an essential requirement for companies in developed markets. However, the asset management industry has a role to play in holding EM companies to account on ESG factors, which will play an increasingly important role in investment decisions.

ESG momentum

Jeroen Bos, Head of Equity Specialties at NN Investment Partners: ‘This report confirms a number of important findings from our prior report on ESG factors in Developed Markets equities. We have now found a clear, positive relationship between incremental changes - or momentum - in a company’s ESG scores and investment performance in both developed and emerging markets. Excluding companies with controversial ESG behaviour also resulted in an uplift of the Sharpe ratio , similar to our experience in Developed Markets. The implication for investors is to consider both level and changes in ESG scores when constructing an EM equity portfolio as both factors contributed to risk-adjusted outperformance.’

NN Investment Partners is using the outcomes of the research to further enhance its company analysis and portfolio positioning with regards to ESG momentum and controversies.

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