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September 26, 2006
Emerging Markets Emerging as Socially Responsible Investing Opportunities
    by Bill Baue

A report by the Ethical Investment Research Services examines 50 emerging market companies using various SRI screens, and finds a number of possible plays.

Emerging markets represent a particular challenge for socially responsible investing (SRI). Traditionally, investors have assumed that companies in these markets have weak environmental, social, and governance (ESG) performance. Compounding this problem, these companies are also commonly understood to lag in transparency on ESG performance. However, emerging market SRI opportunities do exist, as documented in a report released last week by the Ethical Investment Research Services (EIRIS), a UK-based SRI research nonprofit. The report examines the ESG status of 50 emerging market companies according to different SRI screening strategies.

"[EIRIS] found that the overwhelming majority of companies in the study have shown evidence of addressing at least some environmental, social, and governance issues in their public disclosures, with some significantly so," states report author David Tozer, head of governance research at EIRIS. Only eight companies produce no ESG data, according to the report. "[S]ome companies in emerging markets provide CSR reporting that is every bit as good as the best practitioners in the developed world…"

Mr. Tozer cites Hyundai Motors of South Korea specifically, and more generally South African companies, which are bound by regulations to report according to the code set forth in the second King Report on Corporate Governance (or King II). In establishing the prevalence of SRI in emerging markets, he notes the 21 SRI funds in South Africa with $1.6 billion in assets. Looking globally, the International Finance Corporation (IFC) invests some $1.1 billion in emerging markets using both positive and negative screens for ESG issues.

"The IFC argues that any perceived limitations to SRI in emerging markets should not be construed as evidence of a business case against it," Mr. Tozer states. "A strong argument has been made that SRI could both obtain good returns for the investor and be instrumental in encouraging the adoption of socially and environmentally beneficial business activities that will assist sustainability."

"However, this apparent win-win situation begs the question that, if the potential benefits of investing in emerging markets are to be realized, then what kinds of screens and investment approaches might be most effective?" Mr. Tozer asks.

The report sets out to answer this question by examining five types of screens used in the EIRIS Ethical Portfolio Manager ( EPM) software tool: traditional, corporate governance, environmental, norms, and best-in-class. Traditional screens (alcohol, gambling, tobacco, pornography, and military) exclude only two companies: Hyundai and another South Korean company, Samsung Electronics, for weapons manufacturing. With 48 companies qualifying for an SRI portfolio, the report suggests that this may not be the most rigorous method of identifying ESG risks in emerging markets.

EIRIS's environmental screen, which rates companies on environmental policy, management, reporting, and performance and divides companies into low, medium, and high impact categories, finds only 15 companies scoring higher than the midpoint. Looking at company compliance with international norms on issues such as human rights, labor standards, and the Kyoto Protocol, EIRIS finds ten companies with allegations of non-compliance, including two that directly address the allegations.

As for best-in-class screens covering codes of ethics, environment, employees, and human rights, 20 of the 50 companies receive positive scores (raw scores are positive for good performance and negative for poor performance before EIRIS "normalizes" scores into a one-to-ten scale.) Of the 11 South African companies examined, nine score positively, representing almost half the positive scoring companies overall. South African companies also fare well on corporate governance screen, with all 11 firms scoring above the midpoint --"clearly reflecting the impact of the King Code," according to the report. On the other end of the spectrum, all eight Taiwan-based companies scored well below the midpoint.

Unsurprisingly, the report finds that emerging market companies score lower (using the best-in-class approach) than developed market companies in the four sectors with sufficient numbers in the sample for valid comparison: oil & gas, telecommunications, chemicals, and banks.

"The evidence produced by the exercise raises the questions as to whether investors should set different standards for selecting emerging market companies than those for the developed world," the report states. " Investors who want comparable data may feel they need to use the same standards or thresholds for both markets, while others may want to be more lenient and set lower requirements for emerging market companies."

In conclusion, the report points out that the different SRI approaches are not mutually exclusive.

"It would be quite possible, for instance, to combine a 'best-in-class' approach with a screening overlay," Mr. Tozer writes. "The study also indicates clear opportunities for engagement."


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