How ESG analysis adds value in emerging markets

A strong focus on governance standards is the key to successful investing in emerging markets (EM), according to the principals of a new specialist EM investment manager, Remerga.

Remerga’s first fund, the ‘Emerging Markets Sustainable Leaders Fund’, offers access to a concentrated portfolio of stocks in across the emerging markets. Remerga makes its stock selection decisions using a combination of quantitative factors and deep due diligence on sustainability.

Craig Mercer, Remerga’s co-founder, director and CIO, said at a briefing in Sydney last week that emerging markets investing was fraught with complex challenges. He said 30 per cent of the emerging markets benchmark was made up of state-owned enterprises, which might have objectives that do not align with those of minority investors. “We focus heavily on alignments of interest with investors,” he said.

Other issues investors face in emerging markets are inconsistent adherence to the rule of law, uneven sustainability practices and high investment costs.

Mercer heads the Remerga portfolio management team with Warwick Johnson, the other co-founder and director.

Mercer started working in the investment industry in 1999. His roles have included head of global emerging markets Research for Watson Wyatt (now Willis Towers Watson) and head of risk management at Dalton Investments LLC.

Johnson has worked in the industry since 1984. He has served as the head of asset management for HSBC in Japan and founded Optimal Fund Management in 1999. Optimal is a 50 per cent owner of Remerga.

“The fund has been constructed with limited reference to its benchmark, the MSCI emerging markets index. The portfolio is typically comprised to 20 to 40 securities, with consideration being paid to concentration issues and a wide range of risk factors when building our portfolio,” says Mercer.

Remerga will be an active shareholder, engaging with companies on key issues when it is deemed necessary in the interest of members. Mercer and Johnson believe “it is essential to have an engagement process that can aid in enhancing value over the long term”.

“A focus on sustainability is the only way to achieve superior risk-adjusted returns in the emerging markets,” Mercer says.

Mercer cites the findings of a wide range of studies of ESG, which agree that companies with high ESG ratings have lower costs of capital.

Sustainability focused companies outperform their counterparts in both financial performance and market returns. Remerga’s own research has identified the long-term underperformance of state controlled companies in emerging markets.

Governance factors that Remerga takes into consideration include assessing alignments of interest, shareholding structures, audit quality, compensation policies, board independence, capital discipline, related party transactions and controversies involving the company. Other ESG factors that Remerga takes into consideration include an assessment of labour practices and a wide-range of environmental factors.

Remerga has a low investment management cost structure, with fees starting at 45bps (plus a 10 per cent performance fee for returns in excess of the benchmark) in year one and declining in subsequent years.

Mercer says the fees are a reflection of Remerga’s desire to offer value for money and also reflects where the industry is moving to in terms of fees.