‘Moving fast and moving first’ on decarbonisation in emerging markets
“In developed markets we’ve outsourced those high-emitting sectors like cement, steel, chemicals and plastics to emerging markets,” says Matt Christ (pictured), portfolio manager for Ninety One’s fixed income team. “It’s a little bit of ‘not in my backyard’ scenario where we still want those things but we have to produce them somewhere else. If we want to decarbonise the world, what really matters is decarbonising where emissions are generated at the source.”
Christ is currently working on Ninety One’s emerging market corporate credit efforts, specifically its transition debt strategy. Emerging markets represent 60 per cent of the world’s emissions today and are forecast to represent 90 per cent of emissions growth to 2030. At the sovereign level emerging market countries have been reluctant to make rapid emission cuts, and “you can understand why”.
“They’re not the reason we’re in this climate situation,” Christ says. “They’re coming a little bit late to the party.”
Without that “super strong top down leadership”, the responsibility mostly falls to the corporate sector to decarbonise. Christ believes that too many climate investing strategies focus on portfolio decarbonisation rather than real world impact, meaning you need to “lean in” to working with high-emitting countries and high-emitting sectors within them.
“They’re moving fast and they’re moving first,” Christ said. “It’s not necessarily because they think it’s the right thing to do, but because the technologies that are being developed are accretive to the net income of these companies. In many ways adjusting to some of the climate risk mitigations are a cheaper way to generate your product or service. They’ve identified that, in a world of growing climate risk, if you don’t make those adaptations your business is going to have a much higher risk profile than if you do.”
Still, a perception persists that emerging market companies are the “basket children of the global economy”, and relative to the opportunity set the sector is under-allocated to by institutional investors who fret some of the idiosyncratic credit events that geopolitical ructions can create.
“The reality is that this is an asset class that’s $2.7 trillion – it’s bigger than the US and European high-yield markets, and it’s really matured,” Christ says. “It has better credit fundamentals than its developed market peers, and these companies have been in the financial markets for 30 years. They’re banked by the most sophisticated bankers, they use the most sophisticated legal firms, they have the best advisers. They aren’t backwater entities that are suddenly trying to figure out the global markets.”
Christ and the Ninety One team favour a boots on the ground approach to emerging markets, and for good reason. Their distance from the major Western financial centres mean it’s easy for investors to get the wool pulled over their eyes.
One example for Christ came in the mid-2000s, when “out of nowhere” there was an issuance in the public market of bonds for several Brazilian sugar and ethanol companies which until then had issued little to no debt (Brazil is the largest producer of sugarcane in the world). American banks brought the management teams to New York and did “big splashy presentations”. The bonds were cheap relative to their domestic peers, and the opportunity was attractive at face value, but Christ went to Brazil to investigate further.
“I went to mills all over the countryside,” Christ says. “What I learned was that the reason all these bonds were coming to market was because all the Brazilian banks knew that a trough in the price of sugar was coming. In India, the number two sugar producing nation in the world, the government had been providing subsidies to farmers to produce even though prices were low.”
“There was going to be a flood of sugar coming into market. The people in New York had no idea what was coming. It was a rats from the sinking ship situation and the bankers were able to use the geographical distance and the fact that it was a new sector to hide those problems. I think they all defaulted… In emerging markets, believe half of what you see and none of what you hear.”