Sorting out good governance practices from bad ones is crucial to successful investing, because the stakes can be high. NMC Healthcare, a private healthcare provider based in the United Arab Emirates, illustrates how governance risk can adversely affect investors. The company understated its borrowings by US$4 billion over several years. When the extent of its poor governance came to light in 2019, it was placed in administration and bondholders suffered an 80% loss.
But the stakes can be high in a positive way too. For example, efforts by conscientious companies to improve their governance can pay off handsomely for investors. ContourGlobal, a UK-based power generation company with operations in Brazil, Bulgaria and Africa, enhanced its governance and environmental risk profiles by carrying out an initial public offering—making it subject to increased scrutiny and standards of transparency—and committing to build no new coal plants. These initiatives resulted in a significant decline in the company’s cost of funds, and investors in the company’s bonds during this period saw their holdings outperform.
Thus, governance issues shouldn’t weigh too negatively for EM corporations compared to their DM counterparts. But sorting out good from bad governance is indeed tricky, which brings us to our third myth.
Myth #3: Applying ESG to EM corporate bonds is too complicated.
Because ESG risks in this arena can seem impossibly opaque or complex, many investors don’t do the extensive due diligence required to differentiate within the EM corporate sector. However, it’s possible to identify and manage the ESG and other risks associated with EM corporates, given a sufficiently robust research methodology and investment process.
In particular, a 360-degree approach to collaboration across teams of economists, analysts, portfolio managers and specialists in responsible investing ensures the collection and assessment of relevant and timely information.
Such capabilities can identify opportunities as well as risks, making EM corporate bonds a rational and attractive proposition—not only for investors who are explicitly targeting responsible-investment outcomes but also for those who are primarily concerned with capturing competitive risk-adjusted returns.
Myth #4: ESG is too new and too niche to be effective with EM corporates.
ESG terminology may be new, but ESG risks aren’t—and they are real credit risks. Our research has shown that about two-thirds of the EM corporate bonds that underperformed over the past 10 years did so specifically because of ESG reasons, from catastrophic environmental events to accounting fraud. On the flip side, financing terms can be better for companies with strong ESG practices, which strengthens an issuer’s bottom line.
That means that, even if ESG isn’t top of mind for investors, they should incorporate ESG factors into the analysis, because it impacts every EM corporate issuers’ bottom line. And if ESG is top of mind, investing in emerging-market companies can help finance the world’s transition to greater social empowerment and environmental sustainability.
