9.3. The Role of ESG Integration in Emerging Market Investments

Jürg Vontobel Founder, Vietnam Holding Asset Management

In most emerging markets, the availability of relevant and reliable environmental, social, and governance (ESG) information remains the key challenge for ESG integration. This is also true for Vietnam, where very few companies report meaningful ESG data. Therefore, it is impossible to gather reliable ESG information through pure desk research. Vietnam currently has the second-highest economic growth rate in Asia, and thus the environmental challenges continue to be immense. Vietnam also has one of the longest coastlines relative to the size of the country. As a result, the climate change challenges, including rising sea levels and saltwater intrusion into the Mekong Delta, continue to loom large.

An Active-Engagement Approach Combined with Public Engagement

VietNam Holding Asset Management (VNHAM) is a value investment manager dedicated to sustainable equity investments in Vietnam. Its flagship fund, VietNam Holding (VNH), signed the UN-supported Principles for Responsible Investment (PRI) in 2009. VNHAM constantly screens the listed company universe in Vietnam by applying a quantitative analytical process based on key value investment and financial parameters. The firms that qualify for an in-depth financial review are simultaneously submitted to an ESG analysis. Visiting analysts submit an elaborate questionnaire based on the methodology of the Swiss ESG research firm Inrate.

In the fund manager’s proprietary analytical process, ESG performance is weighted equally with the companies’ financial performance. VNHAM reviews its portfolio companies’ incremental ESG progress. The openness and willingness of a company to address sustainability challenges proactively is a prerequisite for VNHAM to invest in the companies.

The main challenge is that VNHAM’s analysts based in Ho Chi Minh City are mostly in contact with the middle-management levels of the companies. They very seldom have the opportunity to convince the top management of the benefits of sustainability principles, despite increasing publicity of environmental challenges and growing ESG awareness. To overcome this hurdle,

the fund manager has developed a direct engagement approach that includes all board members of VNH and VNHAM. Each board member “adopts” several investee companies. The board members are able to engage with the top management of each company at least once a year and seek to obtain very specific commitments to take agreed-upon actions.

The fund manager’s disciplined portfolio management is based on three ESG conviction levels: 1. Limited Conviction: VNHAM agrees with the portfolio company on the required ESG data to be provided, as well as on specific target parameters to be reached within one year. Until such data are available, the company is classified in this lowest category with a target investment level of 3% of the funds’ net asset value (NAV). 2. Full Conviction: Once more ESG data are available, and if the company commits to further improving its ESG practices, the company qualifies for category upgrading with a 5% NAV target.

3. Strong Conviction: The top-performing companies, both in financial terms as well as in their ESG practices, will qualify for the top status with a 7% NAV target.

The investment process awards portfolio companies’ strong financial and ESG performance either with an upgrade or overweighting within the existing conviction range. In the reverse case, the portfolio strategy manager may underweight or downgrade the firm. Each conviction level allows the investment to be adjusted within a defined investment range. On an ongoing basis, VNHAM’s analysts spend as much—if not more—time on their portfolio companies’ sustainability issues rather than on financial performance. Yet VNHAM feels strongly that it is all worth the effort.

The result of this unique combined approach is commendable: Conservative projections of the VNH portfolio growth show a weighted average EPS growth 2017/2018 of 21.5%—28% higher than the marketconsensus EPS growth of 16.8%. 1

Portfolio Decisions Driven by ESG Analysis

VNHAM has divested from companies more for ESG reasons than for their failings to reach financial performance targets. The most common exit cause was insufficient corporate governance standards. In 2013, Global Witness issued the “Rubber Baron” report on Vietnamese companies’ major ESG sins committed through their expansion strategies in Cambodia and Laos.

The very next day, VNHAM initiated an exit from three rubber company investments.

While challenges remain on various fronts, the reporting standards are gradually improving. As of mid-year 2017, 22 out of VNHAM’s 28 portfolio companies had sustainability reporting included in their annual report, of which six followed the GRI G4 standard. The other six published a separate high-quality and detailed sustainability report. The willingness to adopt a sustainable strategy reflects a 360° thinking and long-term strategic planning by a company’s top management, which in turn results in higher long-term profitability for shareholders. The sustainability journey in Vietnam may still be long, but the consistent progress shows that it can be a very rewarding one.

Endnote

1 The market-consensus figure was adjusted by excluding three highly speculative companies, which publish ultra-high EPS growth figures in combination with a micro free-float.