Emerging market debt – Roundtable
of their reporting obligations on ESG. It is not just about climate change. It is investing in companies that are perceived to look after their workforce and supply chain.
It is no longer optional. If emerging mar- ket corporates and sovereigns want invest- ment, being ESG friendly is increasingly a necessity. Sen: ESG risks are increasingly becoming financially material. There are two sides to it: what is your exposure to these risks? How can you impart positive impacts? We want managers to think about those, and we explain that they need robust integration, whether it be proprietary scoring or exter- nal data. On top of that, are they engaging with issuers? Are they talking about the issues that are relevant to their investors? That two-pronged approach is vital, other- wise it is easy to overlook the risks or potential positive impacts.
On governance, managers say we cover ESG because we have looked at govern- ance for decades. That conversation is moving on in that the “E” and “S” are become increasingly important. It is up to us as a consultant, as well as other advisers, to keep pushing conversa- tions in emerging market debt beyond just governance. Wesbroom: One of my frustrations about ESG is that there is no agreed method. At a trivial level, if you ask for an ESG score of a particular company, agent one gives it a positive, but agent two gives it a nega- tive. That feels silly but you have to work beyond that.
ESG is embedded in the way a manager goes about their work. Not every invest- ment manager goes about their job the same way, so we cannot expect them to have a single way of doing it for ESG. What we have to strive for is consistency of the underlying data. The manager can put together whatever interpretation of the data, and that applies just as much in the EM debt world as the corporate world.
There is plenty to play for here. Sen: There is an argument to be made of: does the inconsistency create an ESG alpha opportunity? Which is the next fron- tier in ESG.
PI: What are you expecting to see in the EM debt market in the next 12 months? Mattingly: I expect active forensic manage- ment to produce a mid-to-high single-dig- it performance over the next 18 months. The ESG component is essential to that,
Madhurima Sen Credit manager research Willis Towers Watson
not just because of its financial materiality, but also the perception point that was made earlier.
There are huge opportunities in 2021 if you can avoid the pitfalls, but that is not easy as they are everywhere. Wesbroom: I can see emerging market debt starting to play a greater role in defined contribution schemes as they get to grips with the decumulation challenge. They are going to be looking for assets that offer relatively high levels of stable income, plus or minus currency costs. Arevalo: Our main thesis going into this year has not changed. Global reflation will benefit emerging markets, but different economies are going through different points of the cycle, so you need to differentiate that.
It will be a positive year for emerg- ing markets. As dedicated EM fund man- agers, volatility is good for us. It is relevant to have a robust process, appropriate port- folio construction and managing draw- down for when valuations are attractive again after a prolonged period of spread tightening.
It is never on a straight line. Volatility is part of the asset class and we have to be ready for it. We know how this works. It is taking advantage of it to buy credits at val-
uations where we believe in the long-term fundamentals. It does not work to be a short-term investor. It is difficult to time the market. So, when everything goes down, we can sleep at night because the credits we hold will be able to repay the coupon and principal when they are due. For us, it is having good names through the cycle and taking advantage of volatil- ity to add more value. Pellegrini: Avoiding pockets of drawdowns will be key for alpha generation. ESG is at the heart of this in being able to dodge those curveballs. In terms of the broader market, we see US interest rates continu- ing to rise, but not as sharply as we have seen in the past month or so, which has been rather disruptive to the asset class. With reflation still the name of the game, it will pay to do more analysis in countries that have less room to hike rates to contain inflation and hence dampening a poten- tial economic recovery. Sen: We expect volatility. We will remind clients that this asset class is now an even more valuable diversifier than in previous years. This is cyclical diversification, not just geographical. Deltcheva: It is going to be a big year in terms of ESG and market differentiation. It will be important to track how ESG fac- tors are impacting the decisions asset managers make. ESG risks are gathering
Kevin Wesbroom Professional trustee Capital Cranfield
more attention from regulators and I am looking forward to testing the academic findings from the past 20 years in terms of confirming the value delivered by ESG factors. It will be interesting to confirm whether market participants price in higher ESG risk premiums as well. The approaches we choose – exclusion versus engagement – are something to track as well in terms of the evolution of the emerging market debt asset class.
Issue 103 | May 2021 | portfolio institutional | 27
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