Amidst the global crisis, finding investment opportunities aligned with the UN's SDGs

What are the UN's sustainable development goals and why are they important? Nick Robinson & Catriona Macnair break this down whilst discussing the current global crisis and where investment opportunities fit in with these.

Transcript

Nick: Hello, everybody, and welcome to the abrdn Emerging Markets Equity Podcast. I'm Nick Robinson from the EM equity team. 

In this podcast series, we explore the factors that underpin our thinking on emerging markets, from key individuals to evolving trends, we seek to answer the five W's: Who, What, Where, When and Why,  that are shaping investment opportunities in the region. 

In today's podcast, we're going to revisit a topic we discussed in an earlier episode from April 2021. Back then, we introduced the UN's Sustainable Development Goals or SDGs. And we discussed how they came about and what it's meant for companies in terms of how they might choose to run their business. We also discuss how they influence managing funds that invest in these types of SDG aligned businesses. 

So rolling forward a year and a half, and now with most of the world out of the pandemic, but now enveloped in other crises, we thought it'd be a good time to revisit the subject and see how things are devolved given the huge disruption we've seen to the global geopolitical environment in that time.

So to help me with this today, I'm delighted to be joined by my colleague Catriona Macnair. Catriona is an investment director on the Emerging Markets team, based in London. She has been with the firm 14 years, and as well as her coverage of the financial sector, she also runs our fund that's aligned with the UN Sustainable Development Goals, so she has a wealth of experience in all matters sustainability related. Cat, welcome back to the podcast.

Catriona: Hi, Nick, thank you for having me, delighted to be here. 

Nick: It's great to have you back on. I think on your last outing of the podcast over a year ago, you were telling us about the opportunities in value stocks, so hopefully you can be just as prescient this time.

Catriona: You and me both 

Nick: So perhaps it's worth starting at the beginning and spending a couple of minutes on a refresher on what the sustainable development goals are, and why they're important.

Catriona: Sure, so the scope of the Sustainable Development Goals really can't be overstated. They were defined and agreed by the United Nations back in 2015, and signed by more than 190 countries, so it's a real global effort, and really striving for sustainable economic, social and environmental development globally with the target for 2030. 

There are 17 primary goals, and that's made up of 169 sub goals. So, there's an awful lot going on and within the sustainable development goals. And it's breathtakingly broad, rising every year, I suppose, as we get closer to that 2030 target. And I think the UN's own website actually outlines what the SDGs stand for, in that they're a shared blueprint for peace and prosperity for people and the planet, now and into the future. So essentially, the SDGs define and seek to resolve some of the most significant challenges facing the world today. And they span a number of issues, energy transition and climate solutions, obviously, being some of the most, most obvious solutions within that, but also responsible consumption, production, and restoring social imbalances and reducing social inequalities. So they stand really as a call to action for governments and state,  and they outline the greatest areas of underinvestment allowing policymakers to prioritise spending accordingly. But they're also an independent and universally agreed framework. And I think that's a really, really powerful proposition, serving really as a call to capital, both for policymakers, as I mentioned, but what's more relevant, perhaps for our discussion today is that they serve as a call to capital for asset managers as well. 

And turning the discussion if I may - probably a little bit early - but turning the discussion to emerging markets, where they're estimated to need a staggering - and the numbers here are really, really vast - $3.3 to $4.5 trillion per year, in order to achieve the sustainable development goals by 2030. And when you're looking at the funding gaps, or what that requires to be met, and where we're short, that's $2.5 trillion per year in emerging markets alone. So,   the scope and breadth and indeed, the challenge of achieving the sustainable development goals by 2030 is very significant. But for the most innovative businesses, the blueprint as defined by the United Nations for that better planet and a fairer future for all, also poses a vast potential addressable market and for our innovative companies as I was mentioning, a very profitable avenue for growth long term.

Nick: Okay, thanks. And as I mentioned, you run a fund that's aligned with the SDGs. When you think about managing that fund, what are the objectives of the fund in terms of financial outcomes and also sustainability outcomes and how do you go about measuring those?

Catriona: Sure, so just setting the scene a little bit, I suppose, value-based funds that have negative screens have been around for a very, very long time. I'm screening out certain business exposure such as tobacco or gambling, and then ESG integrated funds have been around more recently. And certainly you're seeing integration of ESG risks with varying degrees of rigour I would say, but they've certainly become increasingly popular in the market as companies, businesses and asset managers indeed, look, look for greater ESG risk integration. What is much more nascent is the idea of ‘profit for purpose’ funds. And that's where portfolios like, like the one I run, as you mentioned, are constructed with a positive environmental and social change angle in mind, alongside conventional financial outperformance that investors will be looking for. So, it's here that I believe the sustainable development goals really can play a pivotal role in portfolio construction. 

And giving you a little bit more colour on the objectives of the fund as you asked about, the fund I run here at abrdn is a profit for purpose fund. It's what we call a dual outcome strategy.  In that it's seeking to achieve long term growth, investing in companies in emerging markets and basically emerging market equities as you mentioned. So firstly, we're looking for a positive contribution to society, and that's through the goods or the services that a company produces and runs. And that has to have an evident alignment with the United Nations Sustainable Development Goals. I'll go into a little bit more about what that means. And then secondly, we're looking for outperformance against the emerging market benchmark. So the dual outcome is really around that positive contribution and then the financial out performance. 

Nick: So, how do you think about the alignment of companies with the SDG goals? And how do you go about measuring that?

Catriona: Okay, I think that's a really important question. And it's become increasingly relevant and with greater ever greater regulatory scrutiny on these funds, quite rightly. So, for us the alignment part is really pivotal part of our investment process. And here we are looking for companies intentionally allocating capital to address a local unmet need or a local shortcoming where we see insufficient access to basic health care, or employment or rising greenhouse gas emissions within that market, and greater electrification, for example. 

So, we look to try and evidence that through very robust research process here, we have sustainable development notes that looks to evidence sufficient materiality and use external data to try and support that local unmet need. Critically, we try to distil those 169 sub goals down into an investable framework. It's a blueprint and a call for action as I outlined, but it certainly isn't designed for investments. So we have come up with our own investment framework which distils those 169 sub goals or 17 headline goals down into eight pillars, and they're really aligned with everyday corporate activity. So rather than going down a thematic route and trying to align specifically with say clima te or water, our fund seeks to offer diversified exposure to try and reflect the breadth of opportunity within emerging markets, but also the breadth of the scope of the Sustainable Development Goals. And we look to span both emerging markets and frontier markets where we see the need as being most pronounced and offer compelling diversification benefits, as I say across a number of those pillars and appealing to a number of those sustainable development goals. 

Nick: Great, and I suppose we, as fund managers, we speak to a lot of clients that are based in places like the US or the Nordics, where the understanding of sustainable finance is quite advanced. I mean, as you, as you move into emerging markets and speak to companies that we actually invest in there, how much of a challenge is it that these companies won't be as familiar with many of the sustainable finance concepts that are more prevalent in developed markets.

Catriona: Absolutely, I think that's very relevant and certainly a live part of our discussions with corporates in emerging markets, certainly they are at the epicentre of some of the greatest challenges facing the world today. So, the SDGs, or the Sustainable Development Goals are, are very relevant, be it environmental issues of deforestation or biodiversity loss, social issues around social mobility, food security, forced labour, and governance issues around the role of the state, particularly in some very significant emerging markets. So I would say companies are increasingly aware of the E, S and the G issues where there is a need for engagement is really around awareness of the Sustainable Development Goals and capital that is allocated towards achieving the sustainable development goals, so that's where we try to engage with the companies, investing companies that we look at, and outline exactly what we would like to see in terms of disclosure. Often these businesses and I’ve mentioned the most innovative businesses are already seeking to address that, that vast opportunity set up to the 2030 target. And we're really here trying to engage with our businesses, encouraging them to disclose what they're already doing in many cases, I would argue that it's a vast opportunity, and there's urgent demand for solutions. So many of these companies are already tackling the problems in their own backyard. They're efficiently allocating capital on a real time basis where they see opportunities to address these unmet needs. And I would make the point that there are a number of tailwinds within emerging markets that are supporting corporates on their journey towards achieving a fairer future for all which I think is worth touching on. 

The first would be around technology, where disruptive technologies are increasingly deployed in a cost efficient way and have the potential to solve these problems profitably and transform lives within emerging markets and frontier markets in a way that there simply wouldn't have been possible previously. So if that's enabling microfinance, for example, the agents to have more digital capabilities, which we can talk through a little bit later, or competitively pricing biosimilar drugs, for example, more cost efficient distribution efforts. 

The second area would be around policy where we're at a real inflection point among certain issues with governments providing very clear targets around net zero carbon neutrality and energy transition. We've seen that with China, for example, committing to carbon neutrality by 2060. But the regulatory landscape is also evolving. And that's important for policymakers and asset managers to bear in mind where the likes of greenwashing and rainbow washing is really forcing the asset management industry to be increasingly stringent in its approach and rigorous in its fund labelling which is, I have to say, is music to our ears. And it means resulting funds are also more aligned and more demanding of their investing companies to uphold what we would consider best practice with regards to operations, emissions, and indeed disclosure, which ties in very nicely with your question and my point around engagements. 

And likewise, the third tailwind that I would discuss today, which is capital flows. So, profit for purpose funds are very much at a nascent stage really, in the emerging market equity space. And global investors aren't yet applying the same thinking to SDG investing as they have done to ESG investing. So I think we're, we're at an inflection point there. But it's a very powerful proposition. And I see these tailwinds and the long-term  opportunities around sustainable development goals, really driving outperformance and we could see that long term where you have traditional impact strategies in emerging markets as really evolving.

Nick: Perhaps it'd be interesting to just talk through a couple of examples of SDG aligned opportunities that you invested in the fund, just to bring a few things to life

Catriona: Absolutely. So the most obvious area would be around sustainable energy, where there's a plethora of examples to select from right across the value chain, really, in an effort to try and reduce greenhouse emissions. And that might be from component manufacturers within China, for example, producing EV batteries or components for EV batteries. And then right through to generation assets in India and China, and even a smart grid enabler that we're able to invest in in China. But the alignment to sustainable development goals is about much more than Sustainable Energy and Climate transition. There are a number of other investable areas that we look at and indeed invest in. Financial inclusion, for example, is a very exciting area where many individuals in emerging markets and indeed Frontier Markets lack formal access to bank accounts or indeed credit. So there's ample opportunities for businesses to invest here and that may include micro lenders, as I mentioned, or mobile money transfers, even digital banks and insurers.

So just to bring some of those case studies to life a little bit. There's a company that we've invested in, in Mexico, for example, a specialist microfinance lender in Mexico and Peru, that actually started out as an NGO about 30 years ago, with a mission to facilitate the development of people and communities through financial inclusion, and in terms of relevant data points and the unmet need, less than 40% of adults have access to bank accounts in Mexico. And there's a huge gender gap. So only a third of adult women have bank accounts and less than 15% have access to credit through formal financial institutions. So, there is certainly an unmet need there that could be addressed through capital markets. 

And here, increased digitalization of field agents has seen working capital loans provided to small businesses who would otherwise lack access to mainstream credit. So that might be bakeries or carpenters, clothes stalls, handicraft sellers, 90% of their clients are women. And those are arguably the most underserved cohort in the country. So digitalization and that tailwind I was speaking about earlier, around technology has really helped a business like this where loan approvals have been slashed from 12 to 14 days - which is an inordinate amount of time if you're one of those informal businesses I was mentioning - now down to a matter of hours and makes a huge difference in terms of your business opportunities and your ability to capitalise on opportunity sets. 

Other chances to invest would be around health and social care. But I would make the point here, it's not as straightforward as you might expect. In emerging markets, exposure to hospitals and clinics is actually a little bit more difficult, in that, often, healthcare companies or hospital companies are serving the really wealthy individuals within a particular market, where they have access to expensive health insurance programmes, for example, or it's medical tourism, where it's people with ample disposable income travelling to a particular emerging market to take opportunity at a cheaper procedure. That's not really what we're looking for when we're talking around targeting these sustainable development goals. So either there's an access angle for health care, or there's an innovation angle. 

Nick: That's great, thanks for those. I mean, they sound like very interesting opportunities, and what a great part of the market to be exploring in terms of investment opportunities. You mentioned earlier the 2030 target date that the UN has, I mean, how do you see the or how are the SDGs evolving at the moment? And I mentioned in the preamble the impact of the pandemic and the war in Russia, Ukraine, I mean, how has that impacted the SDGs?

Catriona: It's less of a rosy picture here I would say in that, we've discussed the pandemic at length and indeed the recent tragedy in Ukraine, which has amplified social imbalances, access to health care, immunisation coverage, for example, which has actually dropped for the first time in a decade, and really worsened inequalities, partly from the two tiered response around healthcare, where healthcare spend shot up, and we saw policymakers really accelerating the agenda globally. But of course, there was a two-tiered response in the COVID vaccine distribution, really worsened those inequalities and those opportunities. Looking at the United Nations own progress report, which they publish every year, they evidence that the pandemic has actually wiped out four years of progress on poverty eradication, and pushed an estimated 93 million more people into extreme poverty. 

So unfortunately, the pandemic and the recent tragedies in Ukraine have really exacerbated global supply chains resulting in soaring food, fuel and fertiliser inflation which has a disproportionate effect on emerging markets and frontier markets. In the UN's annual progress report, the latest report from 2022 made for a rather difficult read. The Secretary General explicitly stated that the aspirations are in jeopardy. And he's outlined that we need to take bold steps to try and address some of these issues. 

In Asia alone for example, the United Nations estimates that at the current rate of progress, the Sustainable Development Goals are unlikely to be reached until 2065. So, we have an awfully long way to go. But there is some good news within that progress report. And that is that there's been considerable progress around the availability of international comparable data in monitoring the sustainable development goals. And in fact, the United Nations own number of indicators has almost doubled. Its best data availability really is around health and energy. And the most difficult has been around climate action. So,  some good news, some bad news.

Nick: Yeah, but certainly sounds like there's even more reason to positively allocate capital to this goal going forward.

Catriona: That's right. Absolutely. You may question whether the Sustainable Development Goals are still relevant. And indeed, I've heard that question one or two times. And to that, I would certainly say that we still need a stretch target. We still need demanding goals to try and facilitate these milestones that we so desperately need. I mean, ultimately, we're all facing the same challenges of accelerating climate change, rapid biodiversity loss, worsening inequalities and imbalances and poor proliferation of plastic pollution. So,    we need to be raising the profile of these issues, warranting greater and greater investor attention, and arguably, from reading the United Nations progress report, there's never been a more urgent time to be focusing on profit for purpose funds. Now more so more so than ever. 

Nick:  Great. Thanks, cat. Well, that sounds like a good place to draw the podcast have a close. So with that, I'd like to thank my guests, cats. Thanks for coming on.

Catriona: Thank you for having me.

Nick: Great, and thank you everyone who took the time today to listen in. If you enjoyed today, then please download our other podcasts from our website or wherever you normally get your podcasts. Watch out for our next episode and tune in.