Impact investing in emerging markets: Growing opportunities, shifting challenges

Emerging markets have long been a focus for impact investors. Home to two-thirds of the global population, these large markets present a wide range of investment opportunities. Developing countries also face many social and environmental problems that will require trillions of dollars to overcome. Throughout the past decade, developing countries have made great strides in addressing these challenges, with policy and regulatory support increasingly providing a tailwind for private-sector companies to innovate on solutions. Today, the fixed income market for impact investing across emerging markets is more mature than ever. In this article, members of our Impact Bond Team discuss their evolving opportunity set and the importance of a bottom-up approach to value creation.

Q: What are some of the bigger impact themes in emerging markets today?

Sam: There are several. The need for investment in the energy transition is significant. In Latin America, for example, financing for clean, renewable energy must double by 2030 and quintuple by 2050 if countries are going to meet decarbonization goals, including achieving net zero. Not surprisingly, the green transition has become a top priority for policymakers, which is creating underappreciated investment opportunities and inefficiencies with mispriced risk.

We have identified companies playing a key role in the energy overhaul. Chile, for example, has set a target to reduce carbon emissions by 82% by the end of the decade and become fully net zero by 2050. The government has been supporting those goals with clear policies. Chilean utilities are now required to supply electricity from renewable sources, and state-owned mining companies — by far the largest utility customers — must source power from renewables as well. So, Chile is shifting the upstream, midstream, and downstream of its energy sector to clean power, which is creating investment opportunities.

Clean water is another investable impact theme. In Brazil, 85% of people have access to clean water and the government aims to get that to 100%. Providing clean wastewater services is an even bigger challenge for Brazil, and they are working on that, too. We identified a company in a key position to help solve these problems. This enterprise has gone from providing two million people with clean water a decade ago, when we first starting investing in it, to covering 30 million customers today. Government contracts underpin its cash flows, so we have a clear line of sight into both the quantum and resilience of those flows. It is another example of the regulatory environment providing a springboard for certain companies.

Suman: I would also add connectivity. Across sub-Saharan Africa, where mobile connectivity penetration is still very low, we have identified several telecommunications companies that are really helping narrow the digital divide. The networks, towers, and consumer products they provide are allowing millions of people to access financial services, education, health care, and other essentials needed for economic stability and progress. Here again, the addressable markets are very, very large.

Q: And what are the main challenges for impact investors in emerging markets?

Suman: Data availability, standardization, and disclosure are among the biggest challenges. But here again, issuers are making progress. We continually work with companies across emerging markets — many of which are small and growing quickly — to help them understand that it is not just us asking for impact key performance indicators (KPIs) or quantifiable evidence around how they minimize negative externalities from products or services. Issuers need to understand that because we and other large investors work globally, we have clients and regulators all over the world that require us to provide that information. If companies come to believe that it is in their financial best interests to provide this data and access a broader investor base, they may do so.

When we first started discussing this topic with one Mexican company, management expressed no interest in providing the information because they were busy with an operational issue. Over time we managed to convince them that the market trend was toward more disclosure and that more investors were going to ask if they were reducing their carbon intensity. When they finally understood that they risked shrinking the pool of capital available to them, they made the effort to disclose their emission-mitigation plans.

Campe: I think another thing that has helped us secure disclosures is the level of trust we have built up with issuers, often through years-long relationships. They come to understand that we have been investing in their industry and managing multisector fixed income portfolios for decades. As impact investors, yes, but also as deeply experienced fundamental fixed income investors, we help them understand that we are investing with them because we believe they can succeed financially. Sam has many years of experience in bottom-up, credit relative value analysis in EMs, particularly in LatAm and Africa, and has been an incredibly valuable addition to the Impact Team. We explain that we know this space very well and are willing to give them ample time to create a plan and execute on their plans and goals.

Sam: Our relationships with climate science experts at Woodwell Climate Research Center and the MIT Joint Program on the Science and Policy of Global Change are also key inputs for data discovery. We can bring climate experts to the table to provide an issuer with an assessment of the physical and transition risk it faces. Thanks to Woodwell Climate, for example, we were able to show the Brazilian water company I mentioned location-specific data around the probability of drought risk and water scarcity across its operations. Having a well-known third-party climate scientist provide this was a game changer. The company’s management team told us that, based on that engagement, they hired an in-house climate expert to help them better model their own forecasts.

Q: Besides securing reliable data, what are the keys to impact investing in emerging markets?

Campe: One thing that we think gives us an edge is the collaboration with our colleagues across various corners of Wellington. This is a tough space to invest in, and it cannot be treated as monolithic. We work with our macro analysts and sovereign credit analysts to understand and parse the macro, political, and geopolitical landscape. We have regional experts like Sam and others who grew up in developing countries and are now part of our team. Those insights are vital, as we could never see the full mosaic for every credit without them.

Sam: For me, working with the rest of the Impact Team across equities and our Impact Measurement & Management Practice has made me a better investor all around. Our ESG analysts, too, provide us with critical assessments of sovereign green bond frameworks and the credibility of various policies. It really is a team effort, combining the fixed income, EM, and impact approach to investing.

Campe: I totally agree. We could not do it alone, and fortunately, we do not have to. Wellington has been investing in dedicated emerging markets portfolios, in both equities and fixed income, for decades. Our impact franchise is nearly a decade old. Engaging with emerging market sovereign and corporate issuers is not new to us, and we are not new to them. That is really the key to investing in this space: time, commitment, research, and collaboration.