Investing in climate change solutions in EMs is a tricky task

EM investors can’t rely on the might of initiatives like CA100+ to help move the needle on net zero

Capturing opportunities driven by climate change such as climate solutions businesses is as important as mitigating risk. But it can be less straightforward to identify quality businesses in emerging markets.

For public equity investors, positioning allocations for lower levels of carbon intensity can potentially reduce exposure to climate transition risk.

Reassuringly, at an index level, the weighted average carbon intensity of the MSCI Emerging Market (EM) Climate Paris Aligned index is significantly lower than the MSCI EM index (about 50% when considering direct and first-tier indirect emissions). Why this might be is evident when comparing the top 10 constituents, where we see that fossil fuel and mining companies such as Reliance Industries and Vale do not appear in the top 10 of the former.

Comparing a benchmark index with its low-carbon counterpart

MSCI EM (iShares MSCI Emerging Markets ETF)MSCI EM Climate Paris Aligned (SPDR MSCI Emerging Markets Paris Aligned ETF)
Taiwan Semiconductor
Samsung Electronics
Alibaba Group
Reliance Industries
Vale S.A., Inc.
China Construction Bank Corporation
Taiwan Semiconductor
Alibaba Group
Samsung Electronics
Samsung SDI
Delta Electronics
Meituan Grupo
Aeroportuario del Pacífico
S.A.B. de C.V.
Samsung Electro-Mechanics
Source: S&P as at 31 January 2023

Lower carbon intensity today, however, does not mean it will be necessarily easy for investors to transition portfolios to net zero, particularly those investing in low-emitting sectors in emerging markets as there tends to be less regulation targeting them and less collective action taken by civil groups, including investors.

For example, Climate Action 100+, one of the most supported investor-led initiatives to engage companies on climate change, is focused on 166 of the world’s highest emitting companies, only 25% of which are in Asia, South America, or Africa. While it makes complete sense for the wider industry to tackle the largest emitters first, it means EM investors can’t rely on the might of initiatives like this to help move the needle for our portfolios. Active engagement as constructive owners becomes key if we are to see much needed progress towards net zero.

When looking at low-carbon indices, it is perhaps surprising that climate solutions companies (i.e., companies that are not just on the path to net zero but are actively developing products and services that help to mitigate climate change) are not more prominent.

While Arisaig’s portfolios are very much off the index in terms of our investments (>97% active share), this has some parallels with our own experience in emerging markets, where we have not found it straightforward to identify listed businesses of the requisite quality that offer solutions to address climate change. Many innovative climate solutions businesses are still too early stage to be listed. Investing in climate solutions also means developing knowledge in new sectors, some of which are highly technical.

Our efforts so far have led to some pockets of potential, however, including Chinese companies in the batteries space, an Indian energy exchange platform, and an Argentinian agri-tech business that produces crops resilient to a changing climate. Having made a start, we are continuously on the lookout for more investment opportunities in the decarbonisation space and are convinced that these will grow significantly in time.