How Social Change Creates Investment Opportunities

Emerging market investing can be a risky business. But companies are making efforts to become less corrupt and have a smaller social and environmental impact

Emma Wall 20 May, 2014 | 7:40AM
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Emma Wall: Hello, I'm Emma Wall. Corporate governance can be a concern when investing in emerging markets. Recently at the Morningstar Investment Conference I was joined by the Nick Edgerton of First State Investments to discuss how social change in emerging markets can create investment opportunities.

Nick, Thank you for joining me.

Nick Edgerton: Pleasure.

Wall: So you like to focus on sort of social macro impact on stocks, although having a very stock orientated view. So taking the sort of Asia Pacific region, one of the things that is a worry in emerging markets is corruption, I mean how does that impact stock selection?

Edgerton: Corruption is very important when we are looking at stock selection. Corruption in an economy can lead to inefficiency. It can lead to poor outcomes for minority shareholders, such as ourselves, invested in listed equities. What we need to understand as investors is; how we are aligned with companies? How close they are to government and political risk? What methods and culture do they have in place to ensure they are well distanced from corruption? We've seen many instances where companies and leaders in companies have been found out in recent times.

For example, just last week in Hong Kong, the head of a resources company who was actually the Chairman of the Ethics Committee of the Commission Against Corruption has been found to be involved with alleged embezzlement of funds. Now these are funds that belong to shareholders at the end of the day. It reduces shareholder return from those companies and it leads to poor outcomes for society and the economy generally.

Wall: Of course, big fund managers can come a-cropper with these. We saw Anthony Bolton a couple of years ago, a fall foul of that. Another one of the themes that you've been looking at is perhaps a positive movement and that China obviously has signed up to reduce carbon emissions, so how does that impact the fund?

Edgerton: We look very closely at long-term environmental trends. There are going to be resource constraints in future. There is increasing environmental pollution challenges in China, carbon emissions are one of those key challenges. Sadly, in China and many Asian economies, through times, some of the renewable or cleantech companies have fallen foul to poor governance practices themselves and led to poorer outcomes for companies and their shareholders.

What we've invested in is what you might call picks-and-shovels companies to cleaner tech industries, so those smaller niche companies that are supporting the renewable energy and cleaner energy technology companies. So, for example, Weifu High-Tech in China is a fuel injection company which leads to more efficient vehicle engines. We also get comfort because they have a relationship with Bosch, the European company. So that gives us more comfort around the quality the governance there.

We also look at listed companies outside of Asia that are generating a great deal of revenue from within China, Waters Corp is environmental testing company, for example, based in the U.S., but with increasing business in China. Xylem, one of the world's leading water companies is another U.S. listed company, but a large part of its business is in water solutions, both quality and quantity for China.

Wall: So, these sort of social measures can be both a negative and a positive screen for stock selection?

Edgerton: There is definitely risk and opportunity when looking at companies on the social factors. We look for companies that understand the long-term sustainability challenge and can position themselves for those challenges, whether they say environmental resource constraints or social equality challenges that they face.

Wall: Nick, thank you very much.

Edgerton: Thank you

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar