‘More Slowly and With a Narrower Focus’

Art by Jonathon Rosen

It’s been a hard few years for emerging markets. The pandemic cut off economic activity, and reopening efforts have been complicated by vaccine procurement difficulties, rising inflation and war. According to Bloomberg data, the emerging markets sector has as investors weigh the risks and opt to head for the exits.

Volatility appears likely to remain elevated in listed stocks and bonds. Robert “Vince” Smith, CIO at the New Mexico State Investment Council, says his outlook for listed emerging markets exposure is less constructive than it has been for a number of years. NMSIC has a mix of private and public exposure to emerging markets. NMSIC’s emerging markets strategies are all actively managed— which enables a more tactical, opportunistic approach .

“For most of my career, we invested in emerging markets for growth, but today a lot of that has changed,” he says. “Globalization is slowing down and I think we’re on the downslope of the globalization cycle we have been in for several decades. That’s going to be hard for emerging markets companies.” Smith adds that if NMSIC were to make a change today it would probably reduce some of its exposure to listed emerging markets equities.

However, public markets don’t tell the whole story. While emerging markets stocks and bonds have been under pressure, there is still activity happening within the private markets. Institutional investors with long-term time horizons are still betting that these markets will make it past the current slate of challenges.

Pre-pandemic, institutional investors were opening up offices in emerging markets and setting up teams to invest in funds and make direct investments. All of that is still happening, albeit at a slower rate and with a narrower focus. Rather than chasing consumer-driven trends, institutions in emerging markets are choosing private markets projects that align with long-term themes.

In April, Ontario Teachers’ Pension Plan Board announced a US$175 million investment into KKR’s road platform in India—a portfolio of 12 road assets including a mix of toll and annuity roads. This was the third infrastructure investment Ontario Teachers’ made in India, following its 25% stake in the National Highways Infra Trust late last year. Ontario Teachers’ is also an anchor investor in the National Investment and Infrastructure Fund, India’s first infrastructure-specific investment fund.

Now, Ontario Teachers’ is reportedly considering opening an office in India as early as next year to continue its investment activities on the subcontinent. If the pension decides to open an office there it will be the second Canadian pension to do so. The Canada Pension Plan Investment Board opened a Mumbai office in 2015.

ESG Takes Center Stage

ESG goals are also factoring into how institutions approach emerging markets. At the start of this year, Dutch pension provider APG invested $750 million to anchor a new fund launched by ILX Management, ILX Fund I, which will make direct-impact private-sector loans in emerging markets; the loans will be targeted to the United Nations’ Sustainable Development Goals and arranged by international development banks.

The private credit fund will support emerging markets loans in four areas: energy access and clean energy; sustainable industry and infrastructure; inclusive finance; and food security. Each of these areas maps to the Sustainable Development Goals.

ILX Management is supported by Cardano Development, a fund incubator focused on local currency-financing strategies within emerging and frontier markets. ILX got initial grant funding to develop its approach from the Federal Ministry of Economic Cooperation and Development (KfW) on behalf of the German Ministry for Development Cooperation (BMZ), the Netherlands’ Ministry of Foreign Affairs and the U.K. Foreign, Commonwealth and Development Office. The firm intends to raise additional institutional private capital for SDG loans and climate finance investments in emerging markets.

A consortium of U.K. pensions is working on a similar strategy. In May, the Church of England Pensions Board along with Brunel Pension Partnership; Border to Coast Pensions Partnership; BT Pension Fund; Environment Agency Pension Fund; NEST; Northern LGPS; Legal and General Mastertrust; Legal and General Workplace Pension Plan and Stakeholder Pension Plan; Railpen; Universities’ Superannuation Scheme Ltd, and West Yorkshire Pension Fund created a group representing almost £400 billion in assets that will work on identifying investment opportunities that support the climate transition in emerging markets.

In a statement on the effort, Rachel Elwell, CEO of Border to Coast, said that the goal of the group was to coordinate with emerging markets to identify ways those countries can meet the climate goals set forth in the Paris Agreement. The group will deliver its action plan at the upcoming 2022 United Nations Climate Change Conference, commonly referred to as COP27, in Egypt in November.

This month, Singapore-based Temasek launched its own S$5 billion climate-focused investment platform, GenZero, to accelerate decarbonization globally. “Achieving net zero globally will require the deployment of around US$5 trillion annually by 2030, to rapidly adopt and commercialize sustainable energy solutions,” said Dr. Steve Howard, chief sustainability officer at Temasek International. “GenZero will not only support Temasek’s efforts as we strive towards halving our portfolio’s net emissions by 2030 and working towards a net zero portfolio by 2050, but also those of the wider ecosystem.”

Many of these projects are also investments in the real economies of emerging markets countries, which have shown resilience even if global listed markets remain volatile.

Asian Development Bank Senior Economist Shu (Grace) Tian notes that throughout the ASEAN+3 countries, many governments and private sector companies are looking at ways to further develop the regional sustainable bond market because of the growing interest in ESG investing. She expects that over the next three to five years the sustainable bond market in ASEAN+3 will continue to grow in size. “There is a recognition that the sustainable bond market can deliver performance and is aligned with the SDGs,” she says. “We are working on a regional standard that will be aligned with international standards so that we can lower the barriers for international investors that have SDG initiatives.”

ASEAN governments—like other emerging markets—were ahead of developed market central banks in raising rates and taking steps to stabilize regional local currency bond markets over the past several months. Those efforts have given ASEAN countries more room to maneuver and focus on long-term plans like supporting sustainable bond issuance. “Even though financial conditions have tightened, the economic fundamentals throughout much of the ASEAN region remain strong,” Tian says.