ESG and growth
Before discussing why an ESG framework is needed for emerging market investors, it is important to address one topic at the heart of the matter: growth.
The concept of growth – in GDP, employment, disposable income, revenue, earnings and so on – is a key factor in assisting us to determine whether something has value or worth. However, the concept of growth presupposes that growth is an inevitable outcome and for that matter a desired one. This paradigm may have some inherent flaws, growth in a finite system cannot be infinite. These “limits to growth” have been well explored and articulated by various philosophers, academics and policymakers over the past 30 to 40 years1; however, they have recently been brought into sharper focus, with the impact of the global financial crisis (GFC) in 2008 and the pressure from issues such as climate and greenhouse gas emissions. Growth, with the incorrect motivation, may similarly prove to be unsustainable and sow the seeds of its own demise. Hence, the ESG lens we use is increasingly important in bringing sharper focus to the sustainability of growth, or rather the concept of “sustainable growth”.
“Much of the focus on efficiency, and short-term profitability, has resulted in a narrow focus, losing sight of key aspects that are core to long-term relevance, purpose and sustainability.”
The ESG framework is particularly important in emerging markets as we analyse state owned enterprises (SOEs), their role within the broader economies and their functioning as corporate entities.
There are numerous important examples to explore regarding the quality and sustainability of growth in emerging markets. There is a limited number of companies that embody perpetual growth (survive)2. Increasingly, and particularly since the 2008 GFC, focus on corporate “growth”, the sustainability of the corporation and the legitimacy of the system that promotes it – capitalism, has moved into sharp focus.
Michael Porter and Mark Kramer in their book Creating Shared Valued3 have provided the beginnings of a framework for reimagining the commercial corporate. They articulate well the crisis of legitimacy that corporates are increasingly facing. Importantly, they capture the real issue – namely the narrow, short-term focus on profit at the expense of deeper social impacts and longer-term more resilient, socially relevant businesses, sustainable ones.
Core to their argument is a provocative challenge to Milton Friedman’s view of corporate social responsibility.4 They argue that today’s corporate social responsibility activities are simply a focus on legitimising a business or managing reputation, seldom connected to the core focus of a business. More specifically, business should be focused on corporate shared value, which, at its heart, recognises that societal needs, not economic needs, define markets, and that social harms and weakness may well create long-term internal costs or inefficiencies for the business.
In many ways this “shared value” paradigm similarly aligns well with the ESG lens that we continue to develop within our business. As such, creation of economic value, by creating societal value, is well framed in focusing on three key areas, namely: reconceiving products and markets, redefining productivity in the value chain and building supportive industry clusters at the company’s location. In this way, the opportunity is to grow the total pot, not reallocate the existing one. Linking this back to the sustainable growth argument, such an approach again provides an additional valuable lens for trying to understand how and who can grow in the world we are moving towards.
We think that using an ESG lens could help in identifying these issues and determine the sustainability of growth. It could be argued that social insight of a demographic dividend is still a tailwind, with the impact of price equalisation equally supportive of sustainable growth. However, debt and environmental challenges, combined with rising inequality, appear increasingly relevant headwinds to many of the emerging markets we assess. rising inequality, appear increasingly relevant headwinds to many of the emerging markets we assess.
“Business should be focused on corporate shared value, which, at its heart, recognises that societal needs, not economic needs, define markets.”
There is no better place to start than with emerging market investments which reflect a large component of state control, social impact, environmental proximity and potential value – the state owned largest emerging market oil and gas giants such as Gazprom, PetroChina, Petroleo Brasileiro (Petrobras) and China Petroleum and Chemical Corporation (Sinopec). State-owned companies have evolved over the last several decades, with some of the largest examples fulfilling the roles that private corporations would fill in developed markets.
In each of the examples listed above, the growth has been staggeringly large – these companies have invested around US$590 billion in just four years between 2009 and 2012.
As such, it might be thought that this must have generated significant economic growth in these economies. Unfortunately, it appears this growth is unsustainable in several different ways.
Value at the intersection of ethics
and skills – ESG identifies sustainable growth
“Most importantly, thorough reform and evolved systems of value creation could continue to lift millions out of poverty and give their children and their children’s children an immeasurably better quality of life.”
Meeting the wealth preservation and growth objectives of our clients is, by its nature, a challenging endeavour. Our evolving ESG lens can play an important role in realising value for our client – and recognising headwinds, from a macroeconomic perspective, is as important as understanding how value can be developed, shared and sustained. Getting it right can have material benefits. For example, if Gazprom was managed half as well as Exxon its share price could increase tenfold10, not even taking into account the social and shared valued that would be accrued.
The pay-offs to action are huge for investors and communities alike. Most importantly, thorough reform and evolved systems of
value creation could continue to lift millions out of poverty and give their children and their children’s children an immeasurably better quality of life. We believe getting this right will provide sustainable wealth creation for our clients.
It is clear that the investment landscape is changing and that the concept of “growth” needs to be considered within a sustainable framework. Hence the ESG lens we use helps us identify risks and opportunities, which may not be apparent by simply looking through a traditional macroeconomic or financial analysis lens – thereby placing an increasingly important role in bringing sharper focus to the sustainability of growth.
Archie Hart, Malcolm Gray and Therese Niklasson are part of the investment team at Investec Asset Management. Therese is Head of ESG Research, Malcolm is a portfolio manager for South African equities and Archie is a portfolio manager for Emerging Market equities, within Investec’s 4Factor team.
1 Reference to Rachel Carstens, Brundtland report, RIO, Millennium Ecosystem Assessment (MEA) COP process etc.
2 Well documented in the Good to Great and Built to Last book authored by Jim Collins et al.
3 IMichael E. Porter and Mark R. Kramer – Creating Shared Value – How to reinvent Capitalism and unleash a wave of innovationand growth, Harvard Business Review, Jan/Feb 2011.
4 Milton Friedman famously argued that Corporate Social Responsibility was a “fundamentally subversive doctrine” in a free society and that “there is only one social responsibility of a business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the games..”. See further, The New York Times Magazine, 13 September 1970.
5 Source MSCI.
6 (Byun et al, 2008). Byun, Kwak and Hwang (2008) “The implied cost of capital of equity capital and corporate governance practices”. Asia-Pacific Journal of Financial Studies v37 pp139-184.
7 The Investec Asset Management Horizon Markets Universe is made up of All MSCI EM less the BRIC countries, Taiwan, Korea and South Africa. Add MSCI Frontier Markets and non-indexed countries.
8 The Investec Asset Management Horizon Markets Universe is made up of All MSCI EM less the BRIC countries, Taiwan, Korea and South Africa. Add MSCI Frontier Markets and non-indexed countries.
9 Source RepRisk ESG Business Intelligence, Investec Asset Management.
10 Currently a barrel of oil and gas owned by Exxon is currently valued at approximately US$18/barrel, a barrel owned by Gazprom is valued at barely US$1/barrel.