Green Dream with GIB AM’s Desai: Companies in emerging Asia understand improving ESG ratings is ‘potent’ for returns

GIB Asset Management's Kunal Desai discusses how engagement is different in emerging markets and his preferred sustainable drink with 'nuisance' ingredients

Companies in emerging Asia have low ESG ratings but an increasing willingness and receptiveness for change, according to GIB Asset Management’s Kunal Desai.

Crucially, he says in this Green Dream video interview, there is also an understanding that this “can be a potent source of shareholder returns”.

Desai, manager of the GIB AM Emerging Markets Active Engagement fund, discusses the shift towards renewable energy in India, how engagement is different in emerging markets and an interesting choice of sustainable drink with ‘nuisance’ ingredients.

Watch the full video interview above and read the transcript below.

NK: Hello and welcome back to the Green Dream video series. I’m Natalie Kenway and today I’m joined by Kunal Desai, emerging markets manager at GIB Asset Management. Thank you for coming in. Could you start off by telling us about the strategy you run and the rationale behind that fund?

KD: Sure. We run the emerging market strategy at GIB Asset Management. It’s a differentiated core, long term and truly active approach to investing in emerging markets. And I think that last point is particularly important, truly active, because there’s been a lot of consternation about what truly active means. For us, active management must be more than just high active share and style biases.

For us, active management must involve a tool of engagement across the portfolio, helping companies along their way to improve their free cash flow power and attractive lower cost of capital. And for us, the perfect environment for this type of investing is in emerging markets. The businesses we focus on are high quality businesses that are undervalued – undervalued not because of deficiencies in their fundamentals, but because of deficiencies in their approach to sustainability, to governance, to capital allocation, to operational issues – which are fixable.

And that’s the role we play as truly active investors.

NK: Okay, great. So where are you investing most of the fund at the moment? Which regions?

KD: About 65% towards Asia, of which the largest proponent is between China and India. India is a market where we see significant runways for growth just in terms of economic development and investment cycle, which is gathering steam, but also very importantly, a much more considered approach to what sustainability should mean and how it can be a source of returns for investors.

The remaining part of the portion is Latin America, Brazil and Mexico. And also we have a few positions in Saudi Arabia, but also Poland as well.

NK: Fantastic. And it touches upon India, that’s not the sort of region that immediately springs to mind when we think about ESG and sustainable investment. Where’s that country in terms of its journey into sustainability?

KD: Yeah, it’s an interesting point because, you know, if we think about four years ago in India, ESG and sustainability wasn’t considered core. But I think management teams now understand the importance that can play for two things; firstly, strengthening their own competitive advantages as a business, and secondly also attracting a lower cost of capital to their companies to allow them to rerate to higher valuations.

See also: – Why the Securities and Exchange Board of India should be thinking bigger on sustainable issues

And I think three things have come together which have helped foster this. The first is an appreciation that as a business, if you see a high ESG rating or sustainability rating, it tends to attract a higher valuation multiple. And we’ve seen in emerging Asia that businesses that are rated triple-A have about a 40% premium to the rest of the market, where triple-C have about a 30% discount.

The second element is businesses appreciate that actually by involving themselves in improving their sustainability make-up, it’s driving forward returns. So ESG leaders in these markets have been outperforming the market more considerably.

And the final point is that not all sustainability rating upgrades are equal. If you’re a business which sits at a triple-C rating, empirical data shows that if you see a two-notch improvement, that registers about a 7.5 percentage points outperformance versus an already good company getting a bit better.

And what we have in India, what we have in emerging Asia, are companies that are blessed with low existing ESG ratings, increase willingness and receptiveness for change, and crucially an understanding that this can be a potent source of shareholder returns.

NK: That’s a really interesting point on the ratings. Thanks for bringing that to our attention. And something we’ve covered recently on ESG Clarity. There is a shift towards renewable energy in India as well. Could you talk a bit about that?

KD: India has had a huge reliance on coal. Historically, it has an abundance of coal and it is a cheap energy which powers the 1.3-1.5 billion people that are in India today. But actually what’s interesting is over the last few years, actually thermal coal capacity hasn’t really moved in terms of incremental investment. Over the next five years as probably about $280bn worth of power generation that’s been earmarked for investment, but 80% of that is focused on renewables. So we’re expecting by 2028, 200 gigawatts of power generation to come on stream of which 140 gigawatts is in solar. Another 25-30 gigawatts in wind. So there’s a huge impetus in terms of power generation to be focused and tilted towards renewables.

Why is that happening? Well, three things, actually. Firstly, government policy is incredibly supportive for this. Secondly, from a technology and an access to finance perspective, that’s been significantly improved over the last three or four years. And also hurdles to bidding processes and bureaucracy and getting essentially our renewable purchase obligations improved has meant that this is a sector which has been transformed in the last three years.

NK: And how does that translate into holdings on your fund, for example? Perhaps you can share some of a recent investment.

From a power generation perspective, we’re a little bit lighter in terms of that investment. Just because the economics for us aren’t necessarily as attractive for an improving return on equity profile. But we do have businesses which are thinking far more clearly and credibly about how they can improve the way they view sustainability.

One of our largest positions in India is a market leader in the building materials space. It essentially manufactures steel products, so their galvanised steel tubes and hollow pieces that go into the construction of urban infrastructure, metros, renewable projects and so forth. And what this business have been able to do is really re-engineer the way in which they think about sustainability, improving that competitive advantage. They’re the first business in India, in their sector, who have now approached net zero with clear, credible targets, both short, medium and long term.

Their business, which is the first to incorporate Scope 1 and 2 for improving their emissions per unit of production. And now we’re on a journey towards Scope 3. But crucially, what this has meant is that now included an emerging market index for the best sustainability businesses across the world. This is a track to lower cost of capital, which has helped rewrite the stock. For us, it’s a win-win when you can essentially attract a lower cost of capital, improving shareholder returns through their improved lens of how sustainability can matter.

NK: Great. That sounds like a very interesting opportunity. And we always ask about engagement, something our readers are really interested in… engagement, stewardship. How open to engagement all the companies that you dealing with in emerging markets?

KD: There’s been a change in the way in which we see engagement it is arguably different from what we see in the rest of the market. For us, engagement needs to happen across the portfolio. All 33 positions in our strategy have this lever of engagement in terms of driving the investment thesis of the company. It’s not done reactively, it’s not done on an ad-hoc basis and it’s not done in a pocket of the portfolio when something has gone wrong.

But rather we invest in these businesses because through the power of engagement change, that’s what drives the investment thesis.

In India, they understand this. There’s an appreciation that if you’re engaging with a company for materiality, say it can help improve their free cash flow power. It can help attract them a lower cost of capital, which helps our market capitalisation rise.

So, finding businesses where the management teams are aligned with us as the shareholders, the way there themselves either own equity in the business or incentivised by share option schemes creates a fabric of framework for when engagement can be far more effective than in in other ways.

NK: Thank you very much for sharing your insights with us. We always end the Green Dream with this question. What’s your favourite sustainable drink or snack?

KD: Well, actually, it’s a good point in the year to talk about this one. As people have tackled dry January and probably finding it quite difficult. And the product is called Nuisance Drinks. I am not sure if you are aware of it but it’s essentially a botanical soft drink, which is actually framed by using stinging nettles as the input of the cordial.

This is a business where stinging nettles – often considered as a nuisance – uses them to create the flavour. And it’s very tasty, there are amazing flavours from cucumber, mint and chilli and so forth. So that’s a business. And it was actually founded by an ex-colleague who was in financial services, has seen the light and is doing something far more interesting!

NK: Thank you for sharing that. Good to have you in the studio, thank you.


Natalie Kenway

Natalie is editor in chief at MA Financial covering ESG Clarity, Portfolio Adviser and International Adviser. She was previously global head of ESG insight for ESG Clarity and has been an investment journalist...