Sustainable companies in emerging markets – growth pearls with reduced risks

Published May 5th, 2010 - 11:15 GMT

The rapid pace of economic growth in developing countries provides an attractive environment for investors. However, the risks associated with emerging markets are higher because they are far more volatile than mature markets. This has to do with the economic structure of the countries concerned, as well as the more challenging environmental and social conditions that prevail. From the investor’s perspective, the most attractive emerging market companies are therefore those which look proactively for solutions which allow them to satisfy sustainable criteria and minimise risks. For its latest report, “Emerging Sustainability - Sustainability analysis of emerging market companies”, Bank Sarasin analysed 360 emerging market companies using environmental and social criteria. The report concludes that there is a reasonable number of companies eligible for sustainable investment.

Emerging economies such as China and India have benefited enormously in recent years from the globalisation of the economy and have achieved impressive growth rates as a result. This growth has brought with it a rise in living standards and domestic consumption. This makes these countries less susceptible to economic fluctuations and allows them to build a broader base for future growth. The International Monetary Fund (IMF) predicts that developing and emerging market countries will achieve annual growth of 6% over the next five years. For this reason, emerging market stocks remain attractive to investors.

Future growth must protect resources
The rapid growth of emerging markets does however present major environmental and social risks. The excessive depletion of natural resources is a key theme here. Further growth must therefore take place in a manner which conserves resources. China has a key role to play here – not least when it comes to water. China has around 20% of the world’s population but only 7% of its fresh water resources. At the same time water pollution is constantly rising.

The emerging markets’ dynamic pace of growth means that emerging markets they will emit more carbon dioxide (CO2 ). In many cases, emerging market countries also face major challenges in the fields of democracy and political stability, labour rights, health, education and social security systems. In many cases too often, corruption and criminality are holding back economic growth.

Sustainability pays off
“Even if more stringent criteria are applied, companies can still be found that achieve a good sustainability rating. These companies are better equipped for the coming challenges, and this will be reflected in lower risks and superior return opportunities. This makes them very attractive to investors.” - Andreas Holzer, Sustainability Research Analyst and author of the report

Sustainability becomes a success factor
As a reaction to the various environmental and social challenges, a shift towards sustainable development is evident on various levels within the emerging economies. Increasing resource scarcity is leading to a long-term rise in energy and raw material prices, while mounting environmental pollution encourages authorities to impose constraints forcing companies to make investments in wastewater purification and air emissions reduction. There is also pressure to improve social standards, particularly in the field of working conditions, because on the one hand consumers are increasingly demanding products which are produced in an ecologically and socially acceptable manner, and on the other because labour is in some cases becoming scarcer in emerging market nations. The financial markets, too, are beginning to promote and reward concern for environmental and social issues. Sustainability, i.e. the proactive search for solutions to these challenges, is therefore becoming a success factor for companies in emerging markets. Risks are reduced, while at the same time opportunities emerge, for example for providers of environmental technologies.

Top rating for Natura Cosméticos
Brazil’s largest cosmetics company consistently uses plant-based raw materials and takes environmental and social considerations into account in procurement. The Ekos product line, for example, uses natural materials from Brazil sourced from local farmers and collectors. Natura fosters long-term relationships with these suppliers. The company is benefiting from the trend towards more natural cosmetics.

Good performance by the sustainable investment universe
For its latest report, Bank Sarasin analysed 360 emerging market companies and identified those which already effectively incorporate sustainability aspects into their business activities. Companies in the grey shaded area (only a selection shown) belong in Bank Sarasin’s universe of sustainable investments. In the period from June 2000 to the end of February 2010, the stocks in this universe saw their value grow by 409% in back testing, while the MSCI Emerging Markets Index advanced 171% (in USD terms). Given the enormous importance of environmental and social risks, and the opportunities associated with sustainable development in emerging markets, giving consideration to environmental, social, and corporate governance aspects when making investment decisions should continue to have a positive impact on the risk/return profile of a portfolio.
In India, Sarasin highlights the following companies:


• The development of sustainable IT solutions is an important part of Infosys' business strategy. For example, the company's logistics optimization solution "LogO", helps companies reduce the carbon footprint of their logistics operations. Green building guidelines are in place for its office buildings and data centres in India. Nearly all development centres in India are certified to environmental management standard ISO14001 & occupational safety standard OHSAS18001. Infosys has not been exposed to any major business malpractices. Generous employee programs (work-life, diversity, health and safety, education/training) are offered in India.

• Tata Consultancy Services (TCS) is the largest IT services company in India, followed by Infosys and Wipro. TCS can help users reduce energy consumption and improve material efficiency by offering services to optimise their operations. TCS has a group environmental management system based on ISO14001, which is rare in the peer group. A quality assurance system is in place group-wide. TCS received a number of awards for being a good employer. TCS has not been involved in any significant negative business practices nor massive job cuts in the last few years.

• Jain Irrigation, India’s largest manufacturer of irrigation plants, particularly efficient sprinklers and drip irrigation systems.

• India-based Suzlon, one of the world’s top three producers of wind turbines.  The company has a 12% global market share and 50% of the Indian market for wind turbines.  Suzlon owns a majority stake in German manufacturer REPower AG.

• Bharti Airtel, India's largest mobile operator, is taking over Zain's African mobile business and thereby turns into one of the major telecom players in emerging and frontier markets. In most of these markets ICT infrastructure is poorly developed (very low mobile penetration rates in rural areas, low internet bandwidth capacity etc.). By applying and exporting the proven low cost model from India, Bharti Airtel has great potential for improving access to and affordability of telecommunication and internet services for new parts of the local population. This opens people new services, sources of information and knowledge and improves economic efficiency


Other stocks mentioned included Cemex of Mexico, the world’s largest cement manufacturer; South African mining company Lomin, one of the world’s largest producers of platinum; South African pharmaceuticals company Aspen Pharmacare, one of the largest manufacturers of generic antiretrovirals for HIV/AIDS; South African Nedbank, the first bank in Africa to adopt environmental and social standards in the field of project finance; Brazilian Itau Unibanco; Brazil-based Natura Cosmeticos, which use plant-based materials and applies environmental and social principles to procurement.

What is Sarasin’s understanding of sustainability as practised in business?
Sarasin defines sustainability in business as the socially responsible production of goods and services with maximum resource efficiency using production methods with a low potential for conflict.


 


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