William Scholes, investment manager for emerging market equities at Aberdeen Standard Investments.
“The mutual fund industry tends to use the ESG and SRI terms inconsistently,” Scholes said. “ESG is a way of looking at risk, ensuring that you treat environmental, social and governance risk as part of operational due diligence.”
ESG analysis is an integral part of Aberdeen Standard’s equity investment process, according to Scholes. “The fund managers are required to think about those risks the same way they think about leverage and balance sheet,” he said.
SRI-focused funds, on the other hand, are a type of investment product that incorporate negative screening on SRI criteria. Such products are designed to meet specific demand of certain investors, for example to exclude weapons manufacturers, tobacco producers, etc.
Aberdeen Standard launched the SRI Emerging Markets Equity Fund in July 2017, as the SRI version of its conventional Emerging Markets Equity Fund, offered since 2010. At the end of February, the SRI fund had $108.7m in assets, compared to the conventional fund’s $5.2bn, according to FE. Both funds are registered for sale in Singapore and available only to professional investors in Hong Kong.
Scholes said that much of the demand for the SRI fund comes from Northern Europe. The product represents a subset of assets managed with ESG concerns in mind. “Emerging markets are under-represented in [ESG funds], whereas the opportunity for ESG and SRI to add value to emerging market equity is equally great [as in developed markets].”
Although implementation of ESG criteria to emerging market equities is in principle the same as for developed markets, there are a few specific challenges. Scholes noted that there tends to be more governance risks in emerging market companies. The shortage of data makes reliance on third-party rating providers less useful and necessitates in-house analysis.
On the engagement front, the awareness of material benefits that come with ESG integration is lower among emerging market companies, so more education is needed as part of direct engagement.
Acceptance of under-performance
The performance of ESG investments versus their conventional counterparts has been a topic of debate. While in principle integrating ESG considerations enhance a fund’s risk management and should therefore improve its long-term returns, FSA‘s analysis found weak negative correlation of ESG scores with fund performance.
“ESG as a way of investing should achieve a portfolio with lower risk,” said Scholes. “Long-term investors can drive value creation through engagement with companies, leveraging your position as a long-term holder to pursue ESG aims. Data shows that companies with best-in-class practices on that front do outperform.”
Going one step further, SRI investments cannot in all fairness be compared to equivalent conventional products, due to the exclusion of certain sectors and companies.
“You apply an additional screening layer to the core portfolio that reduces your investable universe,” Scholes said. “Achieving a market-equivalent return rather than a better-than-market return with a reduced portfolio would be a very good outcome.”
The main value of SRI comes from a portfolio that meets investors’ personal standards and “helps them sleep better at night”, he said. SRI products are not structured to underperform, but exclusion can have an impact on performance.
“When a client applies criteria to screen out a sector that outperforms, they may be accepting a certain level of under-performance relative to an unconstrained index,” he added.
Note: performance of the SRI fund since inception, against its conventional equivalent, benchmark and the category average. Returns in US dollars.
