2022 Investment Views: Sustainability in EMD investing

Transition in focus: EM debt and the path to net zero

Global climate goals require new approaches to capital allocation in EM debt.

Nov 23, 2021

3 minutes

Peter Eerdmans
Global climate goals require new approaches to capital allocation in EM debt.

The fast view

  • As the world’s attention shifts to the transition to net zero, EM debt investors must carefully consider the role they should play and the means by which to achieve this.
  • The investment community’s interpretation of net zero has led to portfolio-level carbon targets that could stymie the world’s net-zero ambition by starving emerging markets of the finance they need to transition.
  • We believe the investment community will need to move away from a myopic focus on carbon intensity and towards a focus on a fair transition for emerging markets.
Q&A with Peter Eerdmans

Sustainability in EMD investing

Hear from Head of Fixed Income Peter Eerdmans on the crucial role of EM debt as the world’s attention shifts to a net-zero transition.

QWhat role can EM debt investors play in the global transition to net zero?

One of the key messages to come out of COP26 is the vital role for investors to play in putting the planet on a sustainable path, given the enormity of the task and the vast sums of money required to achieve it. This is particularly relevant for investors in EM debt; it is no exaggeration to say that emerging markets will determine the world’s ability to reach net zero.

For a start, the transition to net zero by EM economies will mean replacing a lot of infrastructure and investing in renewables, all of which requires capital.

In addition, emerging markets are producers of the vital ingredients for the developed world’s clean energy transition – critical minerals such as copper (used in electrical equipment) and rare earths (used in rechargeable batteries for electric/hybrid vehicles). The world needs these economies to grow and prosper.

In 2022, we think the critical role of investors in providing funding to finance the transition in emerging markets will become an issue that’s impossible to ignore.

QAre current investment approaches up to this task?

Asset managers’ and owners’ interpretation of net zero has led them to set portfolio-level carbon targets that may actually stymie the world’s net-zero ambition. It is quite easy to reduce a portfolio’s net carbon emissions by allocating away from emerging markets. But diverting capital away from them makes it harder for emerging markets to invest in an energy transition and thus puts the global path to net zero in jeopardy.

The flaw in a crude focus on carbon intensity can also be seen in the fact that decarbonisation in developed economies is going to require more emissions in emerging markets, partly from the expected huge increase in demand for a range of raw materials that are critical to low-carbon technologies, most of which are mined in emerging markets, as noted earlier.

Asset owners must commit capital to a transition, and work with asset managers and policy makers to develop common usable standards for transition finance.

QHow do you assess the investment universe from the perspective of net-zero goals?

We take the view that a portfolio should allocate capital in a way that helps emerging markets on the path to net zero. We believe the investment community should move away from a myopic focus on carbon intensity and towards a focus on a transition.

Our approach is to carefully consider each market across a range of issues: what it is doing to transition to net zero; if it has the right plans in place; if it is investing in renewables, etc. The concept of fairness is also key to us, given that most emerging markets are not responsible for the bulk of global emissions to date. We think in terms of a fair transition path to net zero - for emerging markets, the emissions-reduction path might need to be less steep than for western economies to allow them more room to grow, retain jobs, and tackle poverty.

All of the above requires the appropriate measurement tools and existing external data providers typically only cover a small proportion of the EM debt universe. That’s why we built on some of these existing approaches to develop a new index, the Net Zero Sovereign Index, that allows us to rank 115 countries on all metrics outlined above, as well as on land use and deforestation. The index also aims to support sovereign bond investors’ engagements with governments, so that they can hold public officials to account and encourage positive change.

Specific risks

Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems. Sustainable Strategies: Sustainable, impact or other sustainability-focused portfolios consider specific factors related to their strategies in assessing and selecting investments. As a result, they will exclude certain industries and companies that do not meet their criteria. This may result in their portfolios being substantially different from broader benchmarks or investment universes, which could in turn result in relative investment performance deviating significantly from the performance of the broader market.

General risks

All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests.

Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.

Authored by

Peter Eerdmans
Portfolio Manager

Important Information

This communication is provided for general information only should not be construed as advice.

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