ImpactAlpha, August 25 – Environmental, social and governance, or ESG, investing is dogged by inconsistent, and sometimes conflicting, reporting criteria and ratings that make it difficult to analyze risk and impact at best, and disguise greenwashing (or ignite critics) at worst.
One overlooked source of solutions and advice: fund managers in emerging markets, who are used to grappling with investment data scarcity and an absence of robust reporting standards.
Emerging market fund managers’ innovations in collecting information to measure processes (ESG) and outcomes (impact) are helping ESG efforts take shape, even in the absence of a standardized ecosystem.
Organizations such as Circulate Capital, Kiva Capital and Women’s World Banking offer lessons that can apply to investors anywhere, particularly private ones.
Aligning risk and opportunity
ESG investing today has shifted from its roots of screening out investments linked to negative social and environmental impacts, toward a more integrated approach that considers both ESG risks and opportunities. Rather than focusing on ESG as solely a risk mitigation tool, “ESG opportunity seekers” can look for assets with positive ESG impact and use their ownership to increase that impact.
Take Circulate Capital. The firm’s two active funds focus on a significant environmental issue: plastic and its impact on climate change. Within this theme, the firm is also increasingly focused on social and governance issues, working with portfolio companies to put more women in decision-making positions.
Circulate Capital cites both the business case and better climate outcomes as reasons for taking a more proactive approach to investing with a gender lens and providing enterprises with tools and resources to reach gender-related goals. Most of its portfolio companies aim to qualify as suppliers to global companies, some of which are Circulate Capital investors and all of which have supplier diversity initiatives. Efforts toward gender equality therefore increase their appeal.
In emerging markets, fund managers often don’t have the luxury of waiting for more information on how to measure ESG; they have to do this work themselves. They can therefore be a reliable source of data in particular sectors and geographies for investors.
Such data can uncover opportunities to reduce risk and capture financial and impact alpha. It can also support critical evaluation of ESG claims, to help avoid “greenwashing” and similar issues.
“If an investor is new to emerging markets and also new to impact investing, fund managers can serve as trusted intermediaries to help collect specific data on the impact that investors seek through their investments,” says Katrina Ngo, Kiva Capital’s director of impact and investor relations.
Kiva Capital’s team has on-the-ground staff in the regions where Kiva operates who support due diligence and spend time investigating “if investment opportunities are sustainable, not only from a financial standpoint but also from an impact one,” she explains.
Intermediaries can also help identify how to close data and information gaps between portfolio businesses and investors while meeting businesses where they are.
“We have to figure out what data we actually need as a fund manager and try to align that to investees,” says Ngo. “We refer to this as ‘data as a service’: what wouldn’t be burdensome and will impact the business’s own financial and impact performance?”
Fund managers’ experience in this area also means that they have a more nuanced understanding of how to apply different metrics and frameworks for evaluating ESG and impact.
Circulate Capital Ocean Fund, which invests in ocean plastic mitigation in South and Southeast Asia, has confronted the lack of “generally accepted ESG frameworks specific to waste management and recycling,” explains Martin. “We are relying on broadly applicable best practices, tools and frameworks, like the International Finance Corp.’s Performance Standards, and then layering in elements from our impact framework or adopting new ones,” Martin says.
Indicators like the U.N. Sustainable Development Goals and Global Impact Investing Network’s IRIS catalog help with “sense-checking,” she adds. Circulate also relies on an impact metrics working group it convened, which is comprised of experts in waste management, ocean health, livelihoods and gender issues.
There is a unique upside opportunity in helping portfolio companies address ESG issues in their supply chains and operations, including reducing inefficiencies, boosting companies’ resilience to shocks, potentially increasing profits and impact.
Milliman Financial Risk Management has been working with our initiative, USAID INVEST, to explore the usage of gender-based violence as an indicator for economic and political instability in ESG risk analyses.
“If your methodology for gender-based violence means not investing in areas with high gender-based violence, it means you’re not investing in those spaces, which can be detrimental to people living there. Finance is not going towards improving the situation,” observes Milliman’s Josh Dobiac.
Investment managers should consider how to invert the methodology, he adds. “Instead of a binary inclusion versus exclusion, you highlight the risk in the region so investors can think through how they can condition the money going there.”
This can encourage governance, change and oversight that leads to improvement rather than harm. By finding a way to account for and address such types of risk, investors can avoid missing out on promising investment opportunities.
The data collection process itself can present an invaluable opportunity to directly engage companies to influence—and hopefully improve—ESG outcomes.
Both the asset management program and gender lens funds at Women’s World Banking have ESG requirements, which the nonprofit details “right up front in the investment document,” says Christina Juhasz, the organization’s chief investment officer. That way everyone “is on the same page, and they can’t push back on data requests down the road.”
Juhasz cautions that it can take up to a year to help investees understand the type of disaggregated data the organization needs.
With the data in hand, her team is better able to support investees in making their practices more inclusive, both for customers and employees. Its first step is getting management and boards involved in analyzing gender-disaggregated information and help them recognize “how a greater focus on gender parity can impact and drive financial results for the business,” Juhasz says.
(Disclosure: USAID’s INVEST initiative provided technical assistance to the Women’s World Banking Capital Partners Fund II to help its investees with market research and identifying opportunities to recruit women as customers and on their workforces.)
Using the data to shift practices is more complex. Sometimes, Juhasz explains, “the management doesn’t have a good understanding of why they can’t recruit women and will be quick to ascribe it to the culture or some other problem they can’t address.”
Reasons for such issues aren’t always obvious. On the issue of women’s recruitment, the solution might be as simple as providing a safe bathroom in the facility, Juhasz notes.
The fund helps investees dig into how to address key ESG issues.
In the race to advance ESG investing, emerging market managers have cultivated a fertile testing ground for ways to effectively source and apply ESG data, producing creative solutions that investors and investees should pay closer attention to and borrow from.
“Data collection is just the starting point,” says Juhasz. “It’s what you do with the data that becomes meaningful.”
Lauren Yang is strategic communications advisor at USAID’s INVEST initiative