Emerging markets have greatest transition needs, offer most investment opportunity

IN THE past 10 years, emerging markets have accounted for 93 per cent of the rise in carbon emissions. In the next 10 years, they will account for 98 per cent of global population growth.

This makes emerging markets a key part of the global transition story – where the greatest impact is needed, and can be made, if we are going to reach our global net-zero targets.

Decarbonising emerging markets demands serious capital. A global net-zero transition hinges on transforming emerging economies and businesses, with Asia requiring nearly half of the US$125 trillion to make net zero happen by 2050.

Green finance tends to prioritise mitigation in developed economies. Yet, the borderless nature of environmental challenges means that we must tackle emissions wherever they occur.

Moreover, cutting emissions in emerging economies is estimated to cost half as much as in advanced economies due to the relative ease of purchasing clean technologies.

In a study of 10 developing economies, Standard Chartered found that every dollar spent on adaptation in these countries in this decade would result in USD$12 of economic benefit.

This supports a greater allocation of resources in emerging markets, where decarbonising investments will get more bang for the buck.

Challenges in emerging markets

Mobilist, a climate-focused investor and research provider, shows that mainstream environmental, social and governance (ESG) screening has diverted funds away from emerging economies. This is primarily due to a lack of data.

Where company-level ESG data is missing, for instance, investors and data providers use proxies to fill the gaps in their analysis. Sovereign ESG data is frequently used to plug data gaps for entities. Country-level ESG scores are highly correlated to per capita income, however, which means rich countries generally have higher ESG scores.

Furthermore, the lack of data is often interpreted as implying a lack of transparency, which can lead to exclusion.

ESG investors’ focus on financed emissions could also lead to the exclusion of investments, especially if they operate in countries that have a high dependency on fossil fuels.

Related to this is the lack of a clear definition of what qualifies as transition financing. Investors fearful of being accused of greenwashing therefore prefer to stick strictly to green activities.

All these challenges have led to a lack of green financing across emerging markets. Although emerging economies (excluding China) account for over two-thirds of the global population, they currently represent only one-third of global energy investment and a mere 20 per cent of clean energy investment. Further, only about 3.6 per cent of global pension funds are invested in these economies.

Fiscal incentives such as smart carbon pricing and strategic public investments could play a pivotal role in closing the financing gap. The existing regulatory landscape has presented challenges for investors, although efforts are under way to turn this tide.

By implementing clearer regulations and comprehensive transition plans, including national and regional sectoral pathways, governments can catalyse private investment.

This is being addressed by regulators such as the Monetary Authority of Singapore (MAS), which has launched the Singapore-Asia Taxonomy. This framework is the first in the world to include a transition category that accounts for the needs of Asia.

Alpha opportunities arise in imperfect markets

Imperfect information and market bias can offer attractive alpha opportunities for investors who find ways to bridge what the market lacks.

Research-driven investors aim to understand what is beyond the numbers, moving beyond the known facts to seek what the market may have missed. This principle applies just as much to sustainability and transition assessments as it does to financial analysis.

In the high-emitting sectors, the ability to transition is fundamental to an investment case. The conclusion should not be to avoid the sectors, but to invest in the winners and the solution providers.

Investment analysis involves creating frameworks that allow us to establish credible transition candidates. These frameworks should acknowledge the nuances of sector-specific decarbonisation pathways, considering regional and technological differences.

Engagement with companies will facilitate a better understanding of their progress and enable investors to push for ambitious targets. It would also lead to information that can be used to recalibrate models as data and technology continuously develop.

Preparing for the long haul

It has been said that the energy transition is more extensive than the Industrial Revolution, is moving faster than the digital revolution, and will take multiple decades to achieve. Multiple stakeholders are working together to identify and address various leverage points.

The Glasgow Financial Alliance for Net Zero points to three critical intersections: government-level policies and net-zero plans; business’ commitment to decarbonisation; and specific plans for phasing out carbon-heavy assets. Additional players include the private financial sector, multilateral development banks, civil society and local communities.

While significant top-down change is required, it must be met with the bottom-up actions of asset owners and managers to provide research that will create greater transparency and provide solutions that are increasingly mandated by regulators – all to ensure solid financial returns.

Asset owners and managers play a crucial role in this complex ecosystem, acting as stewards of capital who perform a crucial role in the real economy.

To fulfil this role effectively, they need to provide tools and analyses that guide capital towards the most impactful outcomes. This guidance will, in turn, be reflected in investment returns.

Investments should not only drive decarbonisation but also embrace activities that cushion the blows of a disruptive energy transition, including robust adaptation measures.

Thu Ha Chow is Asia head of fixed income and portfolio manager at asset manager Robeco, where Ghislaine Nadaud is senior sustainability investing specialist and Frank Reynaerts is senior credit analyst