Emerging Market Debt
Looking Beyond ESG Scores To A Sustainable FutureJohn Berry
The value of any investment can fall as well as rise and investors may not get back the amount invested.
Sovereign bond investors should focus on emerging markets’ potential for progress rather than just risk scores. Our experience in Uzbekistan is a case in point, as Fixed Income specialist John Berry writes.
Looking for simple answers to complicated questions is part of human nature. In Douglas Adams’ The Hitchhiker’s Guide to the Galaxy, a supercomputer is designed to provide relief to our existential angst and finally answer the “ultimate question of life, the universe and everything”. After 7.5 million years the computer reluctantly delivers its answer: 42. Meaningless questions get nonsensical answers.
ESG investing sometimes feels almost as broad as the ‘ultimate question’, and it is tempting to import vast amounts of data, throw it into a supercomputer to generate an arbitrary number, and then confidently assert that you have ‘answered’ the ESG ‘question’. In practice, of course, the questions you ask depend on what you’re trying to achieve – your purpose.
In investment the traditional goal is to deliver the best risk-adjusted returns for clients. The initial ESG approach was therefore to treat ESG factors only as risks to those returns. This was convenient as it involved only minor tweaks to existing investment frameworks. However, clients have always cared how returns were made, and the surge in interest in ESG reflects a growing dissatisfaction with the investment management industry’s willingness to pursue a quick, but ultimately unsustainable, buck.
Imagining the future
In our Emerging Market Debt strategies our purpose is clear: to generate resilient income for our clients by investing their capital in companies and countries which are contributing to a sustainable future. It is our core belief that countries which invest in their natural, human and institutional capital, and companies which make a positive social contribution, are more likely to prosper in the long run – and therefore more likely to offer attractive long-term return for our clients.
It is precisely in emerging markets where we as investors need to challenge ourselves to avoid looking for simple answers. To have a chance of being successful, a thoughtful ESG approach to investing needs three key elements:
- avoid the seductive simplicity of relying on available data
- be forward-looking and focus on each country’s trajectory
- be considered in the context of each country’s level of development
We believe that our approach allows us to meet our purpose.
Focusing on hard data might seem like a transparent, objective way to assess ESG performance. In reality, it is anything but that. ESG data for emerging markets is incomplete and backward-looking. A data-led approach can therefore fail in its aspirations and risk doing harm by favouring rich countries, well-resourced sectors, and placing too much emphasis on historic performance.
We do not ignore the data, but it is only a starting point when imagining a country’s future trajectory. To deliver great investment performance we need to question the lazy extrapolation of recent trends and instead anticipate deeper shifts in society. We will sometimes get it wrong, and for some people our interpretation of a sustainable future will differ from their own, but our approach is characterised by a willingness to ask challenging questions and back our judgement with conviction.
New beginnings vs false dawns
Our investment decisions reflect this approach. In 2018 we visited Uzbekistan, a year before its first bond issuance. President Mirziyoyev had come to power on his predecessor Islam Karimov’s death, and we had been encouraged by some of his actions, such as releasing political prisoners and tackling forced labour in Uzbekistan’s cotton industry. Although Uzbekistan scored badly on several ESG indicators, our visit confirmed that the commitment to reform was genuine. We use milestones to monitor each investment relative to our hypothesis and with several positive milestones hit we remain impressed by the pace of Uzbekistan’s progress. Uzbek bonds proved relatively resilient during the pandemic, and currently the dollar bonds yield more than double similar maturity US Treasuries, which we see as a healthy source of income for our clients.
In contrast, while we invested in Ethiopia with a similar thesis – that Prime Minister Abiy Ahmed’s reforms would drive the Ethiopian economy forwards, helping lift millions out of poverty – we became increasingly worried that rising tensions between Ethiopia’s ethnic groups were unlikely to be resolved peacefully, and therefore progressively sold our holdings between July 2019 and June 2020. This action was the result of our qualitative analysis of governance factors, even though generic quantitative ESG data was stable. Indeed, the last year saw an escalating civil war and humanitarian crisis and the price of Ethiopia’s 2024 bond has fallen by 20 per cent as debt restructuring now looks likely. Looking beyond the off-the-shelf data and owning the ESG enquiry process is, in our experience, essential.
Ultimately, in-depth forward-looking ESG analysis can uncover both great investment opportunities and potential risks, helping us deliver resilient income while channelling funding to countries that can use it to improve the lives of their people. We believe this is the right way to invest in emerging market debt, one which can deliver great investment outcomes for clients who share our purpose.
look to the future.
Not the past.
The views expressed are those of the Income strategy teams and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
Any stock examples and images used are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
The following page contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
Past performance is not a guide to future returns.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.
Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest,
and with their tax advisers for advice relevant to their own particular circumstances.
Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK clients. Both are authorised and regulated by the Financial Conduct Authority.
Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018 and is authorised by the Central Bank of Ireland. Through its MiFID passport, it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Similarly, it has established Baillie Gifford Investment Management (Europe) Limited (Amsterdam Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in The Netherlands. Baillie Gifford Investment Management (Europe) Limited also has a representative office in Zurich, Switzerland pursuant to Art. 58 of the Federal Act on Financial Institutions ('FinIA'). It does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. It is the intention to ask for the authorisation by the Swiss Financial Market Supervisory Authority (FINMA) to maintain this representative office of a foreign asset manager of collective assets in Switzerland pursuant to the applicable transitional provisions of FinIA. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co.
La presente oferta se acoge a la Norma de Carácter General N° 336 de la Comisión para el Mercado Financiero (CMF) de Chile. La presente oferta versa sobre valores no inscritos en el Registro de Valores o en el Registro deValores Extranjeros que lleva la Comisión para el Mercado Financiero, por lo que los valores sobre los cuales ésta versa, no están sujetos a su fiscalización. Que por tratarse de valores no inscritos, no existe la obligación por parte del emisor de entregar en Chile información pública respect de estos valores. Estos valores no podrán ser objeto de oferta pública mientras no sean inscritos en el Registro de Valores correspondiente.
The securities have not been, and will not be, registered with the Colombian National Registry of Securities and Issuers (Registro Nacional de Valores y Emisores) or traded on the Colombian Stock Exchange (Bolsa de Valores de Colombia). Unless so registered, the securities may not be publicly offered in Colombia or traded on the Colombian Stock Exchange. This presentation is for the sole and exclusive use of the addressee and it shall not be interpreted as being addressed to any third party in Colombia or for the use of any third party in Colombia, including any shareholders, managers or employees of the addressee. The investor acknowledges that certain Colombian laws and regulations (including but not limited to foreign exchange and tax regulations) may apply in connection with the investment in the securities and represents that is the sole liable party for full compliance therewith.
The Superintendencia del Mercado de Valores (SMV) does not exercise any supervision over this Fund and therefore the management of it. This document is only for the exclusive use of institutional investors in Peru and is not for public distribution.
The interests in the following securities have not and will not be registered in the National Registry of Securities maintained by the National Banking and Securities Commission, and therefore may not be offered or sold publicly in Mexico. The interests in the following securities may be offered or sold to qualified and institutional investors in Mexico, pursuant to the private placement exemption set forth under Article 8 of the Securities Market Law as part of a private offer.
Information on the relevant LATAM funds is available on request. Please contact [email protected]
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used are for illustrative purposes only.
YOU MAY ALSO LIKEInsights.Visit Baillie Gifford's Insights page.Actual Income.Client Director Jan Oliver hosts a webinar on Baillie Gifford’s Income solutions. She is joined by James Dow, Torcail Stewart and Steven Hay, investment managers on our Global Income Growth Strategy, our Strategic Bond Strategy and our Multi Asset Income Strategy respectively. The managers explain their investment philosophy and how, through a diversified income portfolio, they aim to deliver repeatable, durable and income-producing solutions for their clients.What is the purpose of a corporation?Today’s investment managers should support companies doing the most to benefit society.Making better sense of the digital ageVirtual goods and the value of digital data pose unresolved challenges to economists, investors and regulators.