Oaktree Capital Management has begun scoring companies in emerging markets based on environmental, social, and governance criteria, a move designed to give it a competitive edge in regions where ESG investing has lagged.
The firm “formalized” its evaluation process over the past year by developing a proprietary model that grades each company it considers for investment across the “E, S, and G verticals,” according to a paper Oaktree released Thursday. The asset manager now uses 69 questions to help it consistently analyze factors such as “workplace fatalities,” emissions, and anti-bribery policies.
“Emerging markets do have vulnerabilities that are different from those in developed markets, chief among them political risk at the country level that can affect the quality of governance at individual companies,” Oaktree said in the paper. “Partly owing to these vulnerabilities, we believe ESG factors are that much more important in EM investing.”
ESG investing is also less crowded in emerging markets, providing more opportunity for investors to gain “attractive returns” from equities in the fast-growing regions, according to Oaktree. Asset tied to “sustainable” investing totaled $30.7 trillion across major global regions in 2018, dwarfing such assets in in Asia, excluding Japan, the report shows.
The Global Sustainable Investment Alliance pegged sustainable assets at $52 billion in Asia ex-Japan in 2016, according to Oaktree. “A lack of quality information remains a challenge in digging deeper into ESG-focused EM investing — supporting this, in one way, is the fact that the 2018 issue of the above mentioned biennial GSIA report did not update this figure but instead has removed the category altogether,” the firm said.
Oaktree sees evidence that sustainable investing strategies pay off in developing economies.
The MSCI Emerging Markets ESG Leaders Index, which tracks companies with stronger ESG metrics relative to their sector peers, has outperformed the broader MSCI Emerging Markets Index over the past decade, according to the report. Oaktree said its own practice of ESG integration has helped the firm “uncover investment opportunities in what are often less-efficient markets, while reducing investment risks and ultimately making us better investors overall.”
[II Deep Dive: UBS Plans Long-Short Fund With ESG Strategy]
ESG practices today can guide investors and companies to higher standards that “materially benefit the bottom line and create broader impact,” according to Oaktree. To this end, the firm said its portfolio managers engaged a low-cost Brazilian airline to provide guidance on its ESG efforts, leading the company to lower its carbon dioxide emission by renewing its fleet with more fuel-efficient models.
“This airline carrier should continue to see significant improvements in its pursuit of more comprehensive corporate stewardship,” the firm said, “as well as a bump in its ESG score in Oaktree’s model.”
The governance factor in Oaktree’s formalized ESG process receives a lot of attention. Thirty of its 69 questions relate to the “G” vertical, including executive compensation and diversity of expertise among a company’s outside directors, according to the report.
Beyond governance, Oaktree said its environment and social scores cover areas including water efficiency, waste disposal, and employee whistleblower policies.
“ESG investing is not just about avoiding disasters and reacting to bad news,” the firm said. “It’s also about recognizing good corporate citizenship and improvements in business principles that are fundamental to a well-run organization.”