Can Emerging Markets Be Socially Responsible Investments?
The Wall Street Journal recently ran a piece on how socially responsible mutual funds, following a larger trend in the investment world, are increasingly putting money to work in emerging markets. While emerging market stocks can bring diversification and growth benefits to a portfolio, there are several issues that a socially responsible investor needs to consider before embracing this trend.
For readers unfamiliar with the term, emerging markets are those economies that are relatively new to global capital markets and are experiencing a period of rapid expansion. In the financial world, emerging markets are considered high risk and volatile investments. While they certainly can perform well during up markets, they often suffer precipitous declines during down markets. A good example of emerging market economies are the so called BRIC countries (Brazil Russia India China) which have seen rapid growth over the past several years.
But for socially responsible investors, there’s more to the picture than just performance. And while the economic growth of these emerging markets has been impressive, the development of ethical business practices often leaves much to be desired. Part of this has to do with the regulatory apparatus in place within these countries, but part of it also has to with the nature of economies experiencing rapid growth: economic opportunity often trumps any other consideration.
When examining the emerging market space, the socially responsible investor should consider the following shortcomings:
Lack of transparency: financial and corporate governance data can often be opaque in emerging market economies, particularly in countries with authoritarian regimes in place, like China.
Lack of regulation: emerging market economies often have fewer workplace and environmental regulations in place with weak enforcement. Also, companies can be difficult to engage on these issues, particularly if they view corporate responsibility as a drag on their bottom line and have no financial incentive (like tax breaks) to reform.
Political overhang: while an individual company may meet certain SRI criteria, the country in which they operate may not, which may make owning stock in these companies untenable to certain SRI investors.
So why are mutual funds with a socially responsible mandate getting into this space? In a word: performance.
According to MSCI, as of 12/31/10, emerging markets have annualized returns of +13.18% per year over the past ten years. In comparison, international developed markets as measured by the EAFE index (Europe Australia Far East) have annualized returns of only +1.06% over the same 10 year period.
When considering this data, it’s clear to see why SRI mutual fund managers who often have to overcome the unwarranted stigma of providing lower returns than traditional mutual funds – are looking for opportunities in a space that has delivered such outsized performance over the past several years.
So how does a socially responsible investor ensure exposure to emerging markets through mutual funds won’t be ethically compromising?
Contact the fund: Most SRI mutual fund companies are very good about providing investment details and their screening practices either on their website or in a prospectus.
Use third party research: Investment websites like Morningstar provide detailed information about company and country exposure for a particular fund.
Work with an investment professional: Find an advisor who specializes in the socially responsible investments to help you determine which funds are most suitable for you.
Image Credit: Wili Hybrid
This article was originally appeared on Just Means.