Emerging markets and the case for sustainable investing

Sustainability-focused capital is much needed in the emerging markets. Using three case studies, we outline opportunities focused on environmental, social, and governance risk mitigation and adaptation.

Key takeaways

  • For investors focused on mitigating global climate and social risks, we believe EMs offer some of the world’s most consequential investment opportunities.
  • We see EM companies currently rivaling their developed-market counterparts in terms of the sophistication of sustainability practice and growth potential.
  • By offering Manulife Investment Management’s expertise in sustainability to EM companies, we seek to accelerate their success, enhance the resiliency of our portfolios, and help our clients pursue more sustainable outcomes.

A concentration of ESG risks and opportunities in the emerging markets

The International Energy Agency (IEA) stated in 2019 that, “There is a new reality in clean energy. The world’s major emerging economies—including China, India, and several others—are moving to the centre stage of the clean energy transition.” In fact, taken as a whole, Asia—which dominates the MSCI Emerging Markets Index—is the world’s largest investor in low-carbon energy sources.1 China alone manufactures 80% of the world’s solar cells,2 and 20 of the top 33 wind turbine suppliers are from Asia.3

This outsize stake in green energy capacity couldn’t have arrived too soon for emerging markets (EMs)—or the world—as Asia is expected to drive more than two-thirds of new global energy demand over the next 20 years, a key period for addressing climate change.4 China now accounts for around half of the global consumption of steel, copper, aluminum, and cement, and it has the world’s largest coal-based power fleet. In the next two decades, the decarbonization of various sectors is likely to be a great source of opportunity for EM investors, but the aggregate investment in sustainable businesses will have to rise substantially if EM growth is to enjoy a positive outlook over the long term.5

We find a similar pattern of opportunity and risk emerging across other environmental and, by extension, social factors. Asia accounts for roughly 60% of the world’s population, as well as 63% of the world’s material use,6 half of the world’s biodiversity hotspots,7 and an inordinate number of issues with catastrophic potential pertaining to water scarcity.8 Asia’s coastal megacities are particularly vulnerable to sea level rise; consequently, Asian populations have been estimated to be 25 times more likely to be affected by natural disasters than people in Europe.9

Investors are drawn to emerging markets because of the growth potential they represent. But if we see a collective failure to coordinate climate policy, practice, and investment, then EM growth itself is more likely to precipitate a disappointing and painful future of ongoing structural dislocations.

Asia is expected to drive more than two-thirds of new global energy demand over the next 20 years, a key period for addressing climate change.

A disconnect of global capital

By certain visible signs, investors appear to be prioritizing systemic challenges such as climate change. Principles for Responsible Investment signatories now represent a significant US$100+ trillion of AUM,10 with one-third of the world’s AUM also committed to net zero emissions.11

Despite this impressive top-line commitment, there’s a disconnect between the capital being allocated to addressing systemic issues and the locations where it’s arguably needed most. Morningstar has calculated that as of March 31, 2021, sustainable funds in the Asia-Pacific represented just 4% of global sustainable investing assets and just 1.8% in Asia ex-Japan ex-Australia/New Zealand.12 Meanwhile, Europe represented 81.9% of sustainable investing assets, even though the EU-28 was responsible for less than 10% of the world’s emissions in 2017, a number that’s likely to decline.

This leads us to make two key observations: first, that sustainable opportunities in EMs are indeed underinvested, and second, the likelihood of making an impact, for much of the world’s sustainable capital, is much lower than it would be if it focused more on the Asia-Pacific. We believe markets and regulatory developments may help correct this situation over time but, in our view, the magnitude of today’s opportunities is only just beginning to become clear.

The likelihood of making an impact, for much of the world’s sustainable capital, is much lower than it would be if it focused more on the Asia-Pacific.

EM companies prioritizing sustainability

While home-country bias may be partly to blame for the disconnect between sustainable capital and the impact it seeks to make, the disconnect may also be a function of certain biased beliefs around EM governance—that it lacks in transparency, oversight, and regulatory standardization across geographies and that state-owned enterprises overwhelmingly assert sovereignty over fair international competition.13 While this critique of EM differentiation may at times feel warranted—particularly because of jurisdictional variation—as active investors, we understand the variegated nature of EMs to be a source of opportunity. Coupled with the impact potential EM investments may have on systemic risk, we think the case is particularly strong for sustainable investing in the asset class.

In what follows, we develop the foregoing observations through three case studies across three sectors: metals and mining, consumer staples, and financials. Our aim with the first two examples is to demonstrate the ascendency of EM companies in terms of sustainability practices, and for the second example, in particular, to connect sustainability to greater brand equity relative to both international and local competitors. In our view, these best-in-class examples seek to take a leading position on sustainability issues in their market segments and/or are actively engaged in solving a sustainability challenge. With our third example, we discuss a case in which an EM company wants to transition its business in the direction of more sustainable practices—and we highlight aspects of our engagement with the company to help accelerate its progress.

South African mining company and the hydrogen economy

Our first example is of a mining company (Company A) whose portfolio includes platinum group metals: copper, iron ore, and metallurgical coal assets (used in steel making). With its differentiated carbon neutrality agenda, the company stands out for both its ambitious emissions-reduction plans and how well positioned it may be to participate in the future of renewable energy markets, which we might call the hydrogen economy.

Walking the talk of sustainable operations

Considering Company A’s scope 1 and scope 2 emissions, company management is setting aggressive and detailed targets for offsetting all major forms of emissions; for example, it’s investigating different recapture techniques to lower emissions due to fugitive methane released at its metallurgic coal sites. For its emissions due to diesel consumption, management is planning to roll out heavy vehicles that run on hydrogen fuel cells, with the first one due to be delivered by year-end 2021. Importantly, the cells’ hydrogen will be sourced through on-site solar power.

With early-stage progress on track for these emissions areas, Company A is also tackling the significant part of its emissions that come from its grid electricity supply. Notably, its South American assets are moving to 100% renewable electricity between 2021 and 2022, with a plan for assets in other locations to follow suit. The company is also responsibly divesting from its thermal coal assets. 

In addition, Company A is at the forefront in adopting new technology to improve efficiency and reduce both water use and its carbon footprint. It uses microwave energy to precondition ores, increasing throughput and recovery, and fiber-optic sensor wraps that surround piping to dynamically model the flow of metal in process. Reducing water intensity of mining operations is a critical issue for mining companies, both for maintaining water licenses in key jurisdictions—such as Company A’s greenfield copper mine in Peru—and for reducing the likelihood of tailings dam disasters. Combining efficiency improvements and reductions in mining’s ecological impact, Company A’s actions are a win-win for shareholders and the environment.

As a sector, mining has struggled at times to shake the bad actor reputation—not always undeserved—as the sector has been associated with devastating events for workers and local communities. Even in our present era of increased scrutiny on sustainable operations, companies involved in metals and mining have caused great damage through rural community disruption, water resource depletion, and pollution in various forms. We believe that Company A, as a standout example for global mining companies, has a credible plan for achieving sustainable operations.

Positioned for the hydrogen economy

While there’s much to applaud in the declining price of renewables relative to fossil fuels, the problem of intermittency—or the reliability of solar and wind being subject to meteorological conditions—has tended to prevent a more dramatic ascendancy for renewables. That’s where technological developments with hydrogen offer a potential solution.

We see the market in hydrogen experiencing a dual-track evolution from where we stand today: the first as a way for industries such as steel to decarbonize and the second as a store for energy generated by renewables. Elements such as platinum are critical assets for Company A, and these find uses in both electrolysers (turning electricity into hydrogen) and fuel cells (turning hydrogen into electricity).

With renewables becoming a bigger and ever-cheaper part of energy generation, renewable energy’s storage through hydrogen is a paradigm-shifting solution to the problem of renewables’ intermittency. Employing electrolysis to convert electricity into hydrogen, renewable power can then be economically stored in salt caverns (which can be manually created if geological conditions allow—as they do in places such as Scotland). This isn’t a new storage technology, as salt caverns have been used for gas storage around the world for decades,14 but its application to the renewables space is more novel.

The economics of a hydrogen economy

The infographic describes what it would take in terms of subsidies to help make green hydrogen cost competitive with fossil fuels, including coking coal, natural gas, and diesel. Assuming $150 billion of cumulative subsidies to 2030, the scaling up of hydrogen as a fuel source could bring its price to $15 per million British Thermal Units (Btu). This cost could then fall further by 2050 to $7.4 per million Btu. At these price levels, hydrogen could replace coking coal, used in steel production, assuming a carbon price of $50 per metric ton of CO2 emissions; natural gas for power generation, assuming a carbon price of $32 per metric ton of CO2 emissions; and diesel for internal combustion engines in trucks by 2031 to 2034.

Source: BloombergNEF, “'Hydrogen Economy’ Offers Promising Path to Decarbonization,” March 30, 2020.  MMBtu is millions of British thermal units. tCO2 is 1 metric ton of CO2. Clean hydrogen refers to both renewable and low-carbon hydrogen (from fossil fuels with carbon capture storage).

Salt cavern hydrogen projects could then be the hubs for distributing hydrogen for electricity as needed, and the hydrogen could be burned in gas-fired generation plants. Of course, burning such fuel creates zero carbon emissions, and the only by-product is water. Long term, this could help save what otherwise might’ve been stranded infrastructure—such as natural gas pipelines, which can carry hydrogen—and natural gas power generation plants, which can burn hydrogen cleanly. Considering the portability of hydrogen in the form of ammonia, renewable energy-rich countries—in Africa, Latin America, and Australasia, for example—could eventually become major exporters of renewable power.

We see Company A as, potentially, a critical commodity producer in the supply chain for green hydrogen (hydrogen created with electrolysers and 100% renewable energy), hydrogen fuel cell development, fertilizer production, sustainable steel manufacturing, and economies of renewable energy storage and transport. And importantly, we think this company could help bring this new energy economy to scale.

Consumer staples company targeting the world’s largest and fastest-growing middle class

If, as the IEA says, there’s a new reality in clean energy, long-term demographic change continues to create new realities at a furious pace for virtually every sector of the Asian economy. As of 2020, two billion people have been estimated to be part of the Asian middle class, but that number is projected to grow to over three billion by 2030.15 The implications of this growth for nutrition, healthcare, labor standards, and customer preferences are nothing short of transformative.

The rise of the Asian middle class

Share (% estimated) of the global middle class by region

The two donut-shaped charts illustrate a regional breakdown of the world’s middle class in 2020 versus 2030. In 2020, the largest component is in the Asia-Pacific, at 54%, followed by Europe (20%), the Americas (17%), the Middle East and North Africa (6%), and Sub-Saharan Africa (4%). By 2030, it’s estimated that the Asia-Pacific share of the middle class will have grown to 65%, followed by Europe (declining to 14%), the Americas (declining to 13%), the Middle East and North Africa (declining to 5%), and Sub-Saharan Africa (declining to 4%).

Source: Brookings Institution, World Economic Forum, July 2020. Middle class consists of households with incomes between US$11 and $110 per day (purchasing power parity) in 2011.

Our next example is of a South Korea-based cosmetics and personal care company (Company B) that sits at the center of a number of long-term trends in Asia—middle-class growth, urbanization, premiumization, and digitalization. Sustainability may be thought of as a fifth trend, though it’s not as prevalent yet in the cosmetics/personal care segment that Company B occupies. And so in this case, we believe part of Company B’s competitive advantage lies in how advanced it may be along the sustainability curve.

A strong ESG profile that’s getting even stronger

In our view, Company B has shown for a number of years that it takes sustainability seriously. We’ve long rated it highly from an ESG perspective for a variety of reasons, but first and foremost, it provides robust disclosure in a dedicated sustainability report. Where few competitors have done this historically, Company B offers clearly articulated processes around governance and consumer product development, as well as strategies and targets for achieving health and safety goals, more sustainable packaging, and transparency in its supply chain.

Company B is also well ahead of many international peers, not to mention local brands in key markets such as China, for using alternatives to animal testing to assess the safety of products, including state-of-the-art tests for toxicity, allergies, and phototoxicity. One stumbling block has been a local requirement in China for animal testing for imported cosmetics and personal care products, but that regulation is now being loosened for general use products. In the wake of this regulatory relaxation, we see Company B being in a strong position to provide safety qualification certificates that would help satisfy China’s local safety assessment requirements.

Daigou distribution and human rights

For foreign luxury companies selling to newly affluent Chinese consumers, there are several modes of driving sales. The first is through traditional storefronts, the second is through online sales, and the third is through a culturally unique manifestation of duty-free sales in China. Known as daigous, these are primarily small-operation wholesale purchasers or syndicates that buy luxury goods abroad and either post or physically deliver these goods to China for resale. With an estimated 20 million daigous in operation today—and luxury brands, including cosmetics sold by Company B, a major focus of their distribution—these intermediaries are responsible for a huge portion of contemporary Chinese consumers’ purchases of foreign luxury goods.16

A distinctive aspect of Company B’s approach to all of its business channels is its stated interest in human rights protection across its supply chain. As described in its 2019 corporate and social responsibility report, the company conducted an impact assessment across several categories, including employees, suppliers, customers, and local communities. Dealing with issues as varied as worksite safety, the provision of mental health services for employees—including for duty-free shop partners—and violation of human rights in the production and supply of palm oil (a key ingredient in cosmetics and personal care products), Company B evinces a credible and comprehensive linking of social risks and human capital management to its long-term business strategy.

Sustainable finance taking hold in Russia

Our third example is of a Russian banking and financial services company (Company C) headquartered in Moscow. In Manulife Investment Management’s one-on-one engagement with the company, management expressed an interest in developing an ESG and sustainability policy and sought our advice. According to the company, its primary goal was to develop sustainability as a core competency. In the resulting communication, members of our EM equity team collaborated with our public markets ESG team to provide strategic suggestions to Company C to help management craft a future-focused ESG policy.

Going beyond the typical criteria of ESG assessment

In our experience, we see ESG data service providers focusing on four components within banking governance: independence, diversity, audit, and compensation. While we encouraged Company C to cover these components in its disclosure, we encouraged management to think beyond these issues, including to developing far-reaching policies concerned with access to finance, consumer financial protection, and environmental financing activities.

Taking environmental financing as an example, we suggested two areas of development.

1 Focus on green businesses

The regulatory backdrop for Company C’s business includes the Sustainable Finance Disclosure Regulation, which imposes mandatory ESG disclosure obligations for asset managers and other financial market participants. As an exemplar of robust due diligence, we pointed Company C toward a major U.S. bank that had undertaken a comprehensive analysis of its environmental financing activities. For Company C, we suggested that such an analysis might also include developing a database on the carbon emissions of companies across sectors, noting where companies are ahead of or lagging in their emissions targets and environmental impact. We explained that while conducting a similar project for Company C might prove to be an involved undertaking, it could be a strong step toward understanding the potential of environmental risks and opportunities across its financial value chain and a necessary step toward participating in a key global finance initiative outlined next.

2 Collaborative initiatives

Company C joined the UN Principles for Responsible Banking, and we encouraged it to go a step further by joining the Net Zero Banking Alliance. This UN-convened forum marks a unification of different finance initiatives with the intention of fostering better coordination of financials sector efforts to accelerate progress toward the low-carbon transition. Among other things, signatories to the alliance—which initially included 43 of the world’s largest banks—commit to establishing a tiered set of science-based net zero targets, as well as sector-level targets for all or a significant majority of specified carbon-intensive sectors.

Finding well-positioned, sustainable EM companies is the task at hand

EMs, and particularly Asia, have a relatively high exposure to a wide range of climate-related and social risks. Still, the underlying fundamentals that contribute to these challenges, including the growing ranks of the middle class and the relatively high rates of economic development, are also what make the region so attractive from an investment perspective. This makes the case for sustainable investing in Asia particularly urgent and compelling, underscoring the importance of identifying the key risks and the companies that are contributing most to helping solve, mitigate, or adapt to systemic issues.

1 IEA, June 4, 2019. 2 Forbes, March 14, 2021. 3 Saur Energy International, July 9, 2020. 4 “Can Solar Power Compete With Coal?” Wall Street Journal, February 17, 2020. 5 “China’s Net-zero Ambitions,” IEA, October 29, 2020. 6 “GO4SDGs Launches in Asia-Pacific to boost resource efficiency and sustainable consumption,” April 21, 2021. 7 UN Environment Programme, April 23, 2018. 8 “Are Asia’s Pension Funds Ready for Climate Change?” China Water Risk, Manulife Investment Management, Asia Investor Group on Climate Change, April 2019. 9 “Asia-Pacific’s Vulnerability to Climate Change,” Asia Development Bank, November 29, 2012. 10 ESG Investor, November 2020. 11 ESG Clarity, March 29, 2021. 12 “Sustainable Fund Inflows Hit Record High in First-Quarter: Morningstar,” Reuters, April 30, 2021. 13 Center for Strategic & International Studies, January 22, 2021. 14 Solution Mining Research Institute, 2004. 15 World Economic Forum, July 13, 2020. 16 In 2016, it was estimated that 80% of Chinese consumers’ luxury shopping was done abroad, particularly by “personal shopper” diagou operations.

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Kathryn Langridge

Kathryn Langridge, 

Senior Managing Director and Senior Portfolio Manager, Emerging Markets Equity

Manulife Investment Management

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Philip Ehrmann

Philip Ehrmann, 

Senior Portfolio Manager, Emerging Markets Equity

Manulife Investment Management

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Eric Nietsch, CFA

Eric Nietsch, CFA, 

Head of ESG Research and Integration Asia, ESG Team

Manulife Investment Management

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