Why Alignment with the SDGs Is Crucial When Investing in Developing Economies
At American Century Investments®, we think impact investing using the U.N. Sustainable Development Goals (SDG) framework is especially crucial in emerging markets (EM). EM countries need greater investment in areas such as infrastructure, technological innovation and education than developed markets. Living standards are among the lowest in the world, and socioeconomic inequalities, including gender and income, can be significant. With some of the world’s most fragile ecosystems, EM countries are also more vulnerable to environmental damage as well as pandemics and rare regional diseases.
The SDGs are an attempt to address the world’s most pressing environmental, social and economic issues. These goals are not materially different from relevant ESG issues. We believe that investing alongside these goals could be a financial opportunity for investors. For example, climate change and hunger are global challenges and the companies that find solutions will benefit. When addressing the various SDG goals, it’s clear that they are most impactful to EM countries. Thus, we believe investors should consider an EM SDG investment because the need is great there.
Investing in companies aligned with the SDGs is consistent with our overall disciplined investment process and aligned with our firm’s underlying commitment to impact investing. Delivering investment results to clients enables us to distribute over 40% of dividends to the Stowers Institute for Medical Research, a 500- person, non-profit basic biomedical research organization. The Institute owns more than 40% of American Century and has received dividend payments of USD 1.6 billion since 2000.
Each stock recommended by an investment analyst for inclusion in our strategy must meet specific criteria, such as alignment with American Century’s investment philosophy and process, alignment with SDGs as well as in-house proprietary ESG risk assessment. American Century’s EM equity analysts do SDG mapping during the fundamental research process.
As part of idea generation, and when the initial fundamental research process begins, our analysts look to find companies whose businesses or corporate actions could generate an SDG impact. Analysts use the APG/PGGM SDG taxonomy framework (a third-party AI-powered platform for investing in the UN SDGs) to assess how a company’s business aligns with the SDGs. As part of the research process, the analyst engages with a company to discuss the company’s fundamentals, and to assess its ESG and SDG activities. The analyst then generates an impact thesis to explain the SDG alignment in combination with the stock’s fundamental investment thesis.
By investing in advancing the SDGs, asset owners and asset managers can play a critical role in creating a more inclusive society. Achieving the SDGs could unlock new market opportunities in food and agriculture, cities, energy and materials, and health and well-being, in addition to creating millions of new jobs in developing countries. While many other SDGs are inextricably linked to the developing world, one of the many notable opportunities is in education.
Access to higher education can help an individual rise above poverty, build a successful career, and take part fully in society. The need for a highly skilled workforce, with advanced technical knowledge, has never been greater. Also, a gap persists between access to education between girls and boys in emerging markets. Research from the ONE Campaign suggests that supplying equal education for children could save the poorest nations more than USD 300 million per day. Addressing this gender cap could also reduce infant mortality in Africa by up to 70%. We have found several education companies aligned with SDG #4, Quality Education, SDG #8 Decent Work and Economic Growth, and SDG #10 Reduced Inequalities.
One such example is the China Education Group (CEG). CEG is the leading operator of private higher education and vocational schools in China. It runs six universities and three vocational schools across China. By supplying quality education, professional training and job placement services that may lead to better employment opportunities, CEG helps reduce poverty and improve working conditions and economic growth potential. The company helps reduce income inequalities and empower women by elevating their social status and broadening access to job prospects. In the case of CEG, results are clear. CEG student enrollment surpassed 181,000 in the first quarter, up more than 6% from 170,000 at the end of fiscal year 2019 the previous August. More evidence of the firm’s success can be seen in its 96% graduation rate for FY17 and FY18 and its 93% first-year placement rate for graduates.
Through our analysis, we are better able to map out how a company’s activities generate impact and outcomes. Outcomes are measured by the most relevant metric, so for our investment in an education provider, for example, it would be the number of students who gain access to higher education and the amount of success they achieve after that through that education. As with education, outcomes for all company analyses roll into one or more of the 17 SDG goals of the U.N.
Before establishing a company’s exposure to an SDG, all stocks will be assessed based on American Century’s proprietary ESG risk assessment framework. We believe that it is essential to ensure businesses are checked for all ESG risks and externalities. Any positive SDG alignment should not be wiped out by harmful ESG risks. This, along with adopting exclusion policies, also protects against “SDG impact washing.”
We believe engagement with a company on SDG issues is an essential part of the investment process. As we already have a dialogue with companies about their business fundamentals, meeting with them on SDG issues is a natural part of that process. The topics of engagement may range from any of the problems that could prove to be material to our investment. We work very closely with our ESG Research team to find ESG risks and externalities. Even though EM corporations are not currently at the level of disclosure seen in developed markets, our experience suggests that corporate willingness to converse and engage on these issues is improving.
As we invest in public equities, the ability to truly measure the incremental impact of our investment in the form of “additionality” is more challenged, especially when compared with private equity or endowment investments, where funding is much more targeted and specific. Despite this, we believe that to achieve the SDG goals in the timeframe envisioned by the U.N., resources must be called upon from all aspects of society. Investment managers in public equities can undoubtedly contribute to this effort. We believe it is crucial to support and invest in companies aligned to SDGs to potentially increase the capital available to them, which could better enable them to advance activities that can lead to positive change.
The importance of impact investing and alignment with ESG goals and SDGs has become increasingly clear in recent years. Environmental and social issues are integrated into all aspects of life today and have influenced how investors and businesses make decisions. The current global health crisis has underscored how crucial impact investing is and the importance it can have in the developing world. The Covid-19 pandemic and its repercussions support the notion that the environment, public health, and the global economy are intertwined. We believe this understanding has helped raise awareness of impact investing and the importance of the SDGs. We found it interesting that the drastic mitigation measures put in place to address the virus may have helped reduce pollution as factory use declined. Apart from highlighting the SDGs, it also puts a spotlight on the “Social” pillar in ESG as investors focus on how a company reacts in terms of its emergency response mechanisms, supply chain control, and employee benefits.
This article was originally published in NordSIP Insights – SDGs 2020: 17 Shades Faster.
When portfolio managers incorporate Environmental, Social and Governance (ESG) factors into an investment strategy, they consider those issues in conjunction with traditional financial analysis. When selecting investments, portfolio managers incorporate ESG factors into the portfolio's existing asset class, time horizon, and objectives. Therefore, ESG factors may limit the investment opportunities available, and the portfolio may perform differently than those that do not incorporate ESG factors. Portfolio managers have ultimate discretion in how ESG issues may impact a portfolio's holdings, and depending on their analysis, investment decisions may not be affected by ESG factors.
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