(March 25, 2013) — One of the barriers to emerging market investment may have been removed by a new index and fund launched by Northern Trust.
The fund manager and custodian has launched an index and linked passive pooled fund that identifies and screens for environmental, social and governance (ESG) issues with emerging market companies.
The index and fund, claimed to be the first of their kind by Northern Trust, were developed with MSCI’s ESG Research and Institutional Shareholder Services’ (ISS) ESG screens.
“We developed the index and fund in conjunction with existing and prospective clients,” John Krieg, managing director for Northern Trust’s asset management arm in EMEA, told aiCIO. “There has been increasing interest in emerging markets, and combining screens for these three factors – including governance – is the newest development for investors.”
Some 22% of global assets are invested from an ESG standpoint, according to MSCI, and last month, analysts at Deutsche Bank said governance was one of the major obstacles to investing in emerging market companies.
The German bank’s analysts said after a boost towards better corporate governance in the early part of the last decade, many companies in emerging markets had barely improved standards. As a result, the analysts said practically all of the sectors and stocks they had identified as “cheap” had fundamentals that were visibly deteriorating.
Last year, Martijn Cremers, associate professor of finance at Yale School of Management, advised investors to stick to affiliates of large multinational companies based in emerging markets to gain exposure to these regions. One of the main reasons was higher-level corporate governance inherent in these firms.
However, Northern Trust claims there are many independent companies based in emerging markets that can be identified using its new index and its screens.
The first screen eliminates constituent companies of the MSCI Emerging Market Index that have been found in breach of the UN’s Global Compact’s 10 Principles. The second removes manufacturers of controversial weaponry, such as cluster bombs – which are forbidden for Dutch pension funds – and lastly, tobacco manufacturers are removed.
Northern Trust said it had worked with many large European investors to find commonality about the types of screens that were required.
After these screens, any company in the index that is deemed to have insufficient independence of ownership, board representation and key responsible committees are filtered out.
Although the fund has been created as a pooled vehicle, this is just the first stage, according to Mamadou-Abou Sarr, senior product specialist for global index management at Northern Trust. “For the pooled fund, the negative screening is all set, but we could manage different criteria for segregated managed of a suitable size,” he told aiCIO.
This fund is the first in a range Northern Trust is ready to take to market. Krieg said a smart beta approach could be applied to the new strategy, for example.
To read Northern Trust’s white paper on applying ESG screens to emerging market investments, click here.