Sustainable Investment in Latin America

In recent years, ESG (Environmental, Social, and Governance) investing has proven itself to be more than just an investing fad - it has become the cornerstone of numerous sustainable investment strategies, even those of major institutions. By assessing the long-term viability of potential investments through the lens of non-financial sustainability indicators, investors are building portfolios that are more resistant to ESG factors.[Read more on how ESG will dominate future discussions of sustainable investment...]Even the World Bank has stated it will incorporate ESG into their overall risk analysis to contribute to more stable financial returns.[caption id="attachment_11012" align="aligncenter" width="651"]

Dow Jones Sustainability MILA Pacific Alliance Index, The COVID-19 crisis is responsible for the sharp downtrend from May 2020 to the date of this publication. Source:[/caption]

Latin America is the right choice for ESG

According to French asset management firm Natixis, Latin America is the target of the most robust demand for ESG investing. According to a Natixis report, 62% of institutional investors in LATAM agree that ESG investing will enhance risk-adjusted returns, while 54% are already incorporating ESG elements into their strategies, and more than half of those surveyed believe ESG mitigates risk. [Download the full report here]. Janne Werning, head of ESG capital markets at Union Investment, adds:"Five years ago, if you wanted to talk to companies about ESG risks like corruption, it would have been difficult to get an answer, but now companies from Latin America are coming to Frankfurt on roadshows to talk about it."The 2017 Social Finance Forum in Brazil – considered "a bellwether for the growth of impact investing in the country" – attracted more than 1,000 participants. In the same period, a survey of 67 organizations active in impact investing revealed that more than 60% of respondents expected net annual returns of 11% and above for 2018 to 2019.Major deals between Latin America's most significant economic blocs and foreign direct investors have paved the way for considerable improvement in ESG across Latin America.The continued shift toward free trade and cooperation, couple with a growing middle class in emerging markets, creates a perfect storm for ESG investment. A recent report from Morgan Stanley reveals that 95% of millennials in the United States share an interest in sustainable investing, while overall interest grows significantly year-over-year. Demographically, the investing world is expressing that social responsibility is a priority. As millennials become the benefactors one of the most significant generational wealth transfers in history, their investment portfolios will stack with companies that exhibit strong ESG values.[caption id="attachment_10998" align="aligncenter" width="646"]

Source: Morgan Stanley[/caption]

Companies that incorporate ESG outperform the competition.

ESG has earned significant traction among investors due to its effectiveness in reducing risk. Companies that exhibit positive ESG traits tend to think long-term, and management teams that strategize for the distant future have a higher chance of outperforming their competitors. According to Vontobel Asset Management, the performance of Latin American companies with the highest ESG ratings significantly outperform their less ESG-conscious peers.Furthermore, large companies in Latin America are shifting towards international shareholding and operations, which pressures the leadership towards more transparent and proactive business strategies. In recent years, Latin American companies have made serious efforts to curtail corruption and achieve best practices, especially in management.However, every investment comes with risks, and multiple studies have highlighted how Latin America has room to improve in various facets of environmental stewardship, social responsibility, and corporate governance.

Adopting ESG improves financial returns for businesses and investors.

In their 2020 annual study, ESG research agencies Vigeo Eiris and Governart ranked several Latin American companies for their integration of ESG. Of the 139 companies assessed, only 5 had more than 30% of women on their Board of Directors. Considering companies with the highest level of racial, ethnic, and gender diversity are significantly more likely to enjoy financial returns that beat the industry average, this statistic alone presents an opportunity for improvement that will benefit stakeholders as well as shareholders.Similarly, while 91% of the companies assessed disclose a strong commitment to anti-corruption, a lack of transparent reporting and internal controls bring such commitment into question. Companies in the top quartile of corporate governance practices in line with ESG metrics outperform those in the bottom quartile in terms of stock returns.[caption id="attachment_11002" align="aligncenter" width="596"]

Performance of the Composite Governance Score, January 2009–November 2017; https://www.tandfonline.com/doi/full/10.1080/0015198X.2019.1654299[/caption]Latin America is also a place of complex cultural differences to other parts of the world where the outcome of adopting ESG practices was studied. For example, while Latin American business is shifting toward a more international structure, family-based governance in the region may exhibit more openness to adopting ESG-based corporate governance practices. Also, data available for ESG and its effects on the success and long-term positive returns of companies is difficult to measure, and much of the data supporting socially responsible investing in Latin America is thin and dated.

Latin America is on the right track, but there's room for improvement.

The Climate Bonds Initiative expects green bond issuance to grow across the LAC (Latin America and the Caribbean) region, driven by a strong need for investment in green infrastructure. Significant opportunities exist in sustainable agriculture, while the area already sports a deep investment in hydrothermal infrastructure. However, hydropower projects are notorious for adverse social and environmental externalities. Issues include the displacement of communities, loss of livelihood, and severe impact on riverine ecosystems.At face value, any investment in alternative or renewable energy appears to be in line with ESG, but even the renewable energy sector comes with caveats. Considering South America is home to four of the top hydropower plants in the world, with Brazil alone accounting for 3.87 GW of hydropower and 11.8 GW in Colombia (70% of the country's total energy production), ESG investors in the region must approach hydropower with plenty of due diligence.Alternative investments also include wind energy. Chile is home to a 607 MW wind farm, while Colombia has set aside $1.8 billion in wind energy capacity over the next three years. Wind power has quadrupled in the region since 2013.

Takeaway

The burgeoning sector of ESG-aligned companies in Latin America offers socially responsible investing that is both effective in its goals and provides a significant return on investments. Investors in this field are wise to consider each investment on a case-by-case basis rather than investing in an index of ESG companies. Even seemingly ESG-positive investments on the surface may prove to be lacking upon more in-depth investigation. The CFA Institute provides a handbook on sustainable investments. Overall, both funding and regional support for ESG is stable and on the uptrend.Learn more about sustainable investment options in Latin America:CANs: Agriculture Investing ReimaginedCANs: Agriculture Investment in Emerging MarketsAgriculture Investing and Green BondsWhy ESG Investment is the Future of Agribusiness