A lot of investors want to be socially responsible with their capital, or have personal beliefs that conflict with investments in certain companies. Maybe they would like to avoid investing in gun companies, tobacco conglomerates, or casinos. An avoidance of oil and gas, or companies with large carbon footprints, is also popular. These investors usually turn to ESG funds.
ESG Funds Are Popular But Inconsistent
Investing with an Environmental, Social, and Governance (ESG) focus has been around for a long time, but has recently picked up in terms of both performance and asset allocation as a new generation of millenial investors focuses on it. There have even been large scale implementations of it such as the almost $1 trillion USD sized Norweigian sovereign wealth fund reducing holdings of oil companies, and even ensuring that banks it invests in avoid companies with large carbon footprints. A lot of fund management companies are beginning to offer ESG funds to cater to this new demand.
But the perplexing fact is that there are no set standards for what ESG investing actually is. An article on ETFdb recently touched on the fact that despite nearly 26% (!) of managed money being devoted to ESG, there is a lot of debate as to what qualifies, and you should take a look at the article here. It really paints the picture that ESG is more about marketing than actual altruistic investing. Most people investing into ESG funds are trying to vote with their money on companies that are upright corporate citizens with a positive impact on the world. It is clear that despite the best of intentions, ESG funds have not always met even these simple basic criteria.
The Case For Frontier Markets As Socially Responsible
So where do frontier markets fit in?
At first glance, not well. Companies in countries in the early stage of economic cycles are usually using dirty fuels, have subpar corporate governance, and work conditions that may be considered draconian by Western standards. It is hard to focus on ESG-related matters when the vast majority of your country’s population live in poverty – the basics have to be met first.
That is why if you take a longer-term view, frontier markets are actually a perfect ESG investment. The transformative effects of a country going from third world and a GDP per capita of under $5000, to becoming an emerging market country with a GDP per capita over $10,000, are incredible. It is only after reaching a certain level of wealth that a country can begin to tackle ESG related issues – before that, there are much more pressing concerns.
Take China’s case as an example. Today, ESG investors would still avoid the country – it is the world’s largest polluter, its companies financials are opaque and handicapped by a number of SOEs, and human rights are an afterthought. Yet its rapid transition from third-world communist country to the economic powerhouse that it is today has resulted in the single largest push of people out of poverty in human history. It is rapidly transitioning from coal and dirty fuels to renewable resources, and is a leader in solar and battery technology. China is not doing this to appeal to countries on the world stage; no, it is doing it because as countries get wealthier, they can afford to tackle problems like pollution, workers rights, and corporate governance because that is what its population can now afford to worry about.
Investing For The Future Using Frontier Markets
Investing in frontier markets, specifically in poorer countries that are in the early stages of development, has the potential to have more of an impact on the lives of future generations than simply avoiding oil companies. It is a tacit acknowledgement of the value of human life in the less developed world, and the transformative power of successful businesses in those countries. The positive ESG benefits are much longer-term and potentially negative in the short-term as the country enters the growth stage, but if your goal as an investor is to have an impact on human life in the future, frontier markets offer the best bang for your buck.