Annika Lombardi: Hi, I’m Annika Lombardi. As the world enters a new phase of focus on sustainable growth, we must focus on the opportunities and challenges this new environment poses to the new entrants on the world stage.
Today, I spoke with Mila Skulkina, lead portfolio manager on Lord Abbett’s Emerging Market Fixed Income Funds, about the importance of equity among the developed and developing worlds and the role Environmental, Social, and Governance policies must play among the governments and stakeholders in this sector of the global economy.
You’re listening to Green Shoots.
Annika: Hi Mila, how are you?
Mila Skulkina: Hi Annika it's great to be here with you today.
Annika: Thanks so much for joining me. I thought, just as an introduction you could walk us through the asset classes you cover, the types of securities you cover just so we could have a little bit of background information before we take a deep dive into ESG and emerging markets.
Mila : Sure, so very briefly I lead the fixed income and emerging markets team here at Lord Abbett and I oversee investments in both emerging market corporate and sovereign space, and I do that across different mandates that includes dedicated emerging market mandates for corporates and sovereigns, for global and multi asset mandates, but majority of my time is focused on fixed income.
Annika: Great and I'm really excited to have you here today because ESG and emerging markets is really an area that seen a lot of new developments recently, but historically has been kind of a tough asset class to incorporate E, S, and G metrics into so I'd love to hear why you as an emerging markets investor believe ESG is an important component of your investment process.
Mila: yeah sure, so I think you know ESG is important to emerging market investors because I think it's really a crucial part of understanding how sustainable the business model is for a particular corporate that we're evaluating or an economic model for the sovereign that were analyzing for investment purposes. Looking back really menu of the ears G factors have always been a big part of the analysis, you know of course governance focus in particular.
Mila: On the corporate side you know, because many of the corporates are owned by families, knowing and understanding the history of treatments of the bondholders and the governance structure in particular is pretty essential to an investment analysis. For the sovereign, I would say that the social aspect to has been important, and it really goes hand in hand with understanding the structural reforms and the trajectory of those reforms really aimed at producing sustainable growth. You know, for instance, access to healthcare, education, literacy rate, unemployment, you know just to name a few of those factors, has always been part of the more sort of traditional analysis, you know, of course, now that we have more focused and more data on the E pillar of the ESG we focus on that as well, but briefly, you know we've always been we've always sort of analyze these governance and social factors in particular.
Annika Lombardi: Thanks that's helpful. And could you talk about some of the historical reasons why ESG may not have, I would say, accelerated as quickly in emerging markets as it has in developed markets?
Mila Skulkina: Yeah you know I think it's a really good question to highlight the broad opportunity set that exists in EM but also really, you know as you highlight the complexities that go along with it. So you know if we take a step back and think about sort of the extensive implication of the 2015 Paris Accord, as well as the subsequent introduction of the US Sustainable Development goals. And you know, really, the commitment to combat climate change to achieve net zero by 2050 you know 190 countries signed that accord.
Mila: And it will be a range of stakeholders that will have to execute on that agreement so it's you know governments across the world that are in various stages of economic development and political cycles, it's the state owned enterprises and sovereigns, its various regulatory bodies, and private enterprises and in addition to really the global finance industry. And you know that transition to me is really actually transformation of you know what the current economic model is to a more greener one, to a more sustainable one, and it will really touch upon and and evolve all the major sectors of the economy from the energy mix and electricity generation to agriculture and transportation infrastructure and how that's all financed, so the banking sector and the finance sector too. If we think about it, that is a really immense undertaking and its scale and in its complexity, and also in terms of the resources that will be required on both on the capital side, but also on you know the time side and the just human capital.
Annika: Thanks, and I know you you already mentioned a few things that are unique to emerging markets but, as you think about ESG factors, is there anything else unique to the asset class, you know, compared to say developed market equities or fixed income?
Mila: um yeah, so I think you know the stakeholder part of it to me is the biggest difference because when you think about you know even on the engagement side right when we engage a with a corporation it's typically on you know either EG dedicated professionals or it's the CEO or the CFO or the investor relations individuals and usually you can track the incentives around you know performance or tie the incentives to certain goals and they could be either you know purely financial goals or, in this particular instance sustainability goals are grand goals that can be agreed upon, and you can draw a pretty straight line I think between the incentives and the outcomes.
I think on the sovereign side you know when we think about engagement and you know partially why I think we haven't seen quite as many you know green bonds or sustainability link bonds in the sovereign space, we have seen a few, to be sure. But not as many not nearly as many as we have seen in the corporate space. I think it's has to do with these incentives and with the length of the particular transaction associated with that.
Annika: Thanks so most of the guests who have come on the Green Shoots podcasts have talked about the types of data or third party ESG data they use and how it's incorporated into the investment process. I know your team does use some of the more traditional data providers like sustainability or msci, but I also know you use a significant amount of additional data in your ESC process. So could you just give us an idea of the types of data metrics you're looking at and how that's incorporated into the fundamental research process?
Mila: Yeah sure, so you know, in terms of the third party providers, we certainly use that as a baseline to look across a variety of sovereigns right? And you know, one of the things that we have to be really aware of is when we look at these scores or the rankings, there have been several studies that have showed a relatively high correlation of the scores in terms of you know quote unquote good ESG score and the wealth and the development of the country or GDP per capita of that particular country, so if you know the reason why we also look at other variables is because if an investor relies solely on those scores, it could really cause sort of a misallocation of capital to wealthier countries from the lower income countries that really need that capital, the most to you know to finance that transition right.
Mila: And so being careful about read domestication of capital flows is something that we are acutely aware.
So what we do is in addition to the several third party providers, we also use several other data sources across the three pillars; it's close to 30 now. Mostly it's data from the World Bank, the UN, we also use several other indices, like the Yale and environmental performance index. We use the Notre Dame global adaptation index focusing on the climate and actually readiness to improve the resilience of that particular sovereign, for the World Bank data will look and I like looking at the actual single individual metrics where you can really look at the trajectory as well, because as emerging market investors, I think we're all very well aware of the data issues and the potential lags that can be associated with it, so thinking about what does the five or the 10 year trajectory look like across you know, five or six different variables within the E pillar or the G pillar. I think it’s really helpful and what we do is you know for these other variables outside of the third party providers it really breaks into two parts. One is to look at the static picture and that allows us to have cross country comparison and we can think of it, whether you know, we want to compare countries within a particular region like Latin America or eastern Europe, for instance or across different credit ratings like you know triple B’s are single B’s, for example, and then two is really looking at the trajectory of improving or deteriorating one, and then we can you know one director research to really say hey you know this looks interesting we wouldn't have uncovered this, how do we just look at the overall score, even if it was for the eat pillar, but you know within the pillar, you know this particular variable looks interesting or for the governance spiller etc. And then we can director of research to try to understand what is driving that but also to think about whether or not it's properly reflected in the market spreads.
Annika: See you mentioned the World Bank data that you look at, could you just give us a couple examples of specific ERS metrics that you think are relevant.
Mila: yeah, of course. So on this pillar we look at the carbon emissions and intensity. And we also look at the energy generation composition, so you know I think actually one of the Latin American countries is a good example where, you know, I don't think many people are aware, but you know over 65% of their energy over their electricity Max actually comes from renewable sources. So, looking at looking at that energy mix is important and again looking at how it changes over time. From the social perspective we look at variable such as unemployment, secondary education we look at mortality rates literacy and just various measures of inequality. And for the governance perspective we look at things like political stability, corruption will look at the role and we look at the rule of law as well.
Annika: Thanks that's very helpful. So moving on… talk a little more about the difference between corporate and sovereign issuers and I know you've touched on some of this already, but could you give us any examples of how evaluating SG for an emerging market corporate would differ from evaluating an emerging market sovereign?
Mila: Yeah, sure. So for the corporate, you know as we discussed it's a little bit less of a complicated stakeholder sort of landscape. However, you know, and the menu corporates are owned by families and so it's either family or conglomerate structure so on the governance aspect that certainly can complicate or add the layer of complexity into the governance analysis and you know with corporates to kind of coming back to the point of you know, being careful with just overall third party provider scores.
Mila: Those two can be positively correlated with the size of the of the corporate, in particular, and we certainly see that this bifurcation and emerging markets where we have you very large corporates with vast resources.
And some smaller players across the world, and you know when we as investors talk to these companies, they are you know definitely willing to show how committed they can be to ESG, however, you know from the investor field. I think that some of the asks and the questionnaires, you know we're not, as you know, we're not as coordinated, as can be in it, we should just appreciate it, it is, it is sort of an additional cost to the company.
In terms of the human resources and the capital, and so I think that you know, once the standards are streamlined, I think it will be beneficial for the some of the smaller players and I think you know, this is not an issue just for emerging market corporates I think it goes to, you know, I think it goes across sort of the world from developed markets smaller companies as well, but that's definitely the feedback. On that i've heard from from the issue of burgess you know hiring lots of extra you know folks in the human resources and also just going through many, many questionnaires that may be repetitive, which is something that I found interesting that that I wanted to share with you.
Annika: Thanks so you've mentioned engagement, a couple times already i'd love to hear a little more about your engagement process with EM corporates and sovereigns as well as maybe some examples of the ongoing types of engagements you're you're involved in.
Mila: yeah sure, so I think you know, in terms of the sovereign engagement specifically for ESG I think it's a relatively natural extension of discussing long term sustainability risk with the sovereign itself. And you know, even though some of the ESG issues may not have an immediate effect but it's certainly very important for the long term health of the country. And you know, having this conversations with a debt management office, the Central Bank and the Ministry of Finance, I have certainly seen a big difference, you know even from five years ago in terms of discussing this issues and understanding, you know from from the sovereign issue or side what importance, it has to the investors, but also what importance, it has on the sustainable economic model of the sovereign. You know the other interesting thing here, and you know it also goes a little bit to the earlier questions that we discussed around you know differences between corporates and sovereign,
Mila: but I think you know, on the sovereign side multilateral institutions like the International Monetary Fund or the World Bank, they can also play very interesting role, which is not something that we have you know, on the corporate side. But you know, the International Monetary Fund it loans and provides Technical Assistant that is already meant to help member countries to think about how to tackle their balance sheet, you know how to tackle their balance of payments problems, for instance, or how to think about restoring sustainable economic growth, especially post the pandemic that we have experienced. You know, I think that they can go further, and I really do think that they can complement the sort of more traditional crisis resolution role with more explicit perhaps green economy targets or progress monitoring, along with you know all the other monitoring that they do.
Mila: On the pillar I think would be on the environmental pillar I think would be really helpful and especially if we think about you know frontier markets or you know single bees or double be rated countries, for example. And you know, in terms of other ways to engage with the issuers, in the last few years, you know I think there's been sort of more formal groups that are being formed that takes together, you know different investors that invest in the same sovereign or quasi sovereign, for instance. And they engage sort of collectively, so we have been a part of a couple of working groups with climate action 100 and we're involved with nationally owned petroleum enterprises in Latin America and Middle East. And for the last I would say 12 to 18 months, and you know what I think is very interesting about these conversations and discussions is that on the issuer aside, you know they really do want to understand sort of why they should care about what can be sort of perceived as a you know advanced economy driven agenda, and I think part of that engagement.
Mila: I've already seen you know changes in is just basically getting on the same page, and you know education around concerns of what climate change can mean and how it can you know materially impact the well-being of the sovereign of the well-being have stayed on enterprise and, by the way, not too distant future.
And also thinking and talking about well, what are your peers doing in a region, what are your peers doing on a global basis, so sort of thinking about what the best practices can be on a going forward basis, I think has been really useful. What I think is also very interesting about these engagements is that there is a very, very strong link obviously between the government ownership of these entities and the state-owned enterprises themselves as a you know, on a standalone basis, and so you can think about a variety of engagement strategies.
Annika: Could you give us some examples or an example of any trades, you may or may not have done due to ESG factors?
Mila: yeah sure, so we were looking actually at a sovereign investment in Latin America, and we were looking at a particular sovereign issuer there, and even though the third party overall score hasn't changed, when we were looking at the world being data that I’ve described earlier, we saw divergence were on the environmental pillar, there was some slight there were some improvement went on the governance spiller across you know six or seven different metrics there was a substantial deterioration in the trend. And we've spent you know significant amount of time researching that and debating that and thinking about whether or not this is, you know proper this risk
of deteriorated and governance is properly really reflected in the spreads and we have decided that it was not so we did not make that investment which I don't think would have been a parent if we hadn't dug into those specific variables.
Annika: Definitely makes the case for active ESG investing.
Annika: Could you talk about why ESG is important to you personally?
Mila: um yeah so you know I am a very strong believer in sustainability, and you know just being responsible with the use of the resources that we have on this planet Earth. I think it probably goes back to my university studies, where I was at UCLA and there was you know just a lot of conversations happening around you know education on the subject and really just daily debates with my classmates conversations with professors and it really just sharpen my view of the environmental responsibility broadly I think early on. But also the speed at which it has to be addressed and so as an investor now you know witnessing that ESG movement sort of unfold over the last several years, and the rapid growth of you know both ESG product, but ESG products but also says explicit you know goals from companies and some of the countries with regards to climate and environment.
Mila: I find it incredibly you know uplifting and just hopeful about the future so I’m just very you know, on a personal level very excited to be a part of it, and you know I think especially in emerging markets where you know I do think that the standard of living, can be improved so if we can be done in a sustainable manner, and I can play a small part in it that's you know I will be very happy person.
Annika: And then, finally, as we finish up here, are there any current events, so our recent news headlines in emerging markets that kind of reflect the complexity of evaluating ESG and this asset class.
Mila: yeah, so I think you know, one of the big stories that has been going on this year and, specifically, in the last three months was tied to property. And that's you know, a very complex subject on its own, but what I would say is you know if we think about how important it is to evaluate the governance in emerging markets on the corporate and on the sovereign side thinking specifically about the corporate you know, on it specifically on the governance side and thinking about the reporting and quite, quite honestly, the capacity of their reporting had been an issue. And so now it's really coming to the forefront, whereas I would say, you know, a year ago and kind of going in the past I don't think the investors had paid as much attention because you know, yes, you get your annual report and perhaps you get sporadic updates.
You see that a lot, you know in EM were a little bit more investment in just reporting and in frequency of reporting could go on could go a very long way in improving some of those some of those factors.
Annika: Great Thank you so much for your insights today, I really enjoyed our conversation.
Mila: I did, too, thank you very much for having me.
That’s all for this episode of Green Shoots. Learn more about Lord Abbett’s commitment to sustainability by visiting our website, Lord-Abbett-dot-com, and be sure to like and subscribe to Green Shoots for more insights. See you next time.
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