A serious approach to ESG in emerging markets is increasingly a proprietary approach.

Investors have long been aware of the impact that certain material environmental, social and governance (ESG) indicators can have on asset risk and performance. They increasingly expect to see these risks addressed across their entire portfolios—including in emerging markets sovereign and corporate debt—and they are beginning to differentiate between their external asset managers based on the sophistication and effectiveness of their approach to ESG investing.

We have been integrating ESG indicators into our sovereigns investment process for eight years. We started working with the ESG research and rating agency Sustainalytics five years ago to build coverage of our corporates universe, and have since expanded our partnerships with MSCI and TruCost. Over recent months, as we have taken further steps to enhance our own processes, we have drawn some conclusions about best practice in integrating ESG into emerging markets debt strategies, and particularly corporate bond strategies, based on our experience.

First, because corporate risk is especially sensitive to sovereign risk in emerging markets, relevant sovereign ESG indicators should feed into corporate ESG analysis just as sovereign credit indicators feed into corporate analysis, and that sovereign ESG analysis should be as rigorous and comprehensive as possible.

Second, more rigorous empirical research continues to show that ESG indicators are linked to credit spreads and credit ratings, but it also helps us to isolate those indicators that are directly relevant and material to companies.

Third, investors can get very useful data from ESG research providers, but it is important to rely on proprietary data and analysis whenever possible, particularly on governance indicators, because there is evidently no standardization in what the research providers are measuring and therefore no guarantee that their data is relevant to investors’ concerns.

And fourth, in addition to integrating ESG indicators into the investment process, engagement on ESG issues is both critical and effective for bondholders.

We discuss these four conclusions in more detail in this article.

The Materiality of Proprietary ESG Scores and Proprietary Weightings

Neuberger Berman ESG scores for 303 issuers plotted against those issuers’ credit spreads and credit ratings

Source: MSCI, Sustainalytics, Neuberger Berman. The first chart shows the proprietary NB ESG scores, and the second chart shows the average proprietary NB ESG score for each credit-rating bucket, for the 313 JPMorgan Corporate Emerging Markets Diversified (CEMBI-D) issuers that provide full ESG data. Data as of October 1, 2018.