Emerging markets (EMs) can offer investors unparalleled scale and scope for change in a world where impact bonds are set to play an increasingly vital role, says Insight Investment² portfolio manager Simon Cooke.

In a world where about 600 million people still live on less than US$2.15 a day³ and 2.2 billion people are without safe drinking water⁴, can global investors make a genuine difference to their plight?

‘Yes’, is the resounding answer from Insight portfolio manager Simon Cooke.

With over US$370bn EM hard currency impact bonds outstanding across ‘use of proceeds’ instruments such as green, sustainability and social bonds, Cooke believes impact bond investing will play an increasing role in improving the lives of millions of people living across EM geographies.

“The challenges facing EM countries are huge,” he says. “Around 85% of the world’s population lives in EMs, covering a global land mass of 77%. The size of the investable market and the scale and scope for change in EMs is, we believe, unparalleled.”
 

Cooke points to the vast infrastructure needs across EM markets as key areas in urgent need of new investment.

“About half the population of EMs have no access to public transport. In an ever more connected world, 600 million people living in EMs also have no connectivity to 4G telecommunications. We see massive infrastructure improvement needs across EM markets and some of the fastest economic growth is now coming from these countries, which is very exciting news for investors,” he adds.

Making an impact

Describing impact investing’s influence and attractiveness, Cooke points out that while investors in impact bonds do seek to make a favourable impact and a real difference to EM populations, their investments are not driven purely by philanthropy. Impact investing, he adds, can not only bring positive impacts and outcomes but also deliver some attractive financial returns.

“EM impact bond investing can offer some compelling returns and that is where the sector gets really interesting,” he says.

“There are other asset classes where you can probably make more ‘impact’ and there are other asset classes where you may be able to achieve higher financial returns. But we don’t think there is any other asset class where you can get the same level of impact and financial return in a single strategy.”

Since the global financial crisis, Cooke says EM corporate bonds have delivered some consistently high returns, with generally low default rates outside of markets such as China, Russia and Ukraine.

“The current economic outlook sees all EM regions growing faster than developed markets (DM) and overall EM-DM growth differentials are now back at decade highs.  While people often assume that EM corporate debt issuers will present much higher risks than those in DMs, they have only been marginally more volatile than European investment grade investments over the last decade or so,” he adds.

Cooke believes a broad approach to impact investing works best and can allows investors to flexibly allocate capital across markets and sectors.  Pointing to opportunities in EM infrastructure development, he says: “Over the next three to five years we believe significant opportunities will arise in the build out of affordable renewable clean energy in EM. We also think there will be other infrastructure build out as EMs in markets such as sub-Saharan Africa look to expand their telecommunications connectivity.”

Safety first

No investment is risk free and Cooke stresses that good research is key to making informed investment decisions in the EM impact bond sector. While issuers need to demonstrate they really are delivering positive impacts, he adds, other factors must also be considered when investing in EM issuers, such as the broader focus of their businesses.

“Impact investors are looking for a positive outcome. But investing in, say, a company which devotes 60% of its time and resources to solar panel manufacturer while devoting the other 40% to supporting the gambling industry is probably not the most sensible or beneficially impactful allocation.

“Effective impact bond investing calls for high levels of transparency in terms of where investment money is going and in receiving accurate reporting of what the funding is really achieving. Good research is also very important, when targeting and identifying issuers with a clear path to repayment,” he adds.

If investors can navigate these hurdles, Cooke believes they face one of the most exciting and innovative fixed income markets in the world.

“Not only is the EM impact bond market growing rapidly, but the innovation we are seeing across EMs is incredible and beyond what we are seeing in Europe,” he adds.

“Only very recently we saw the launch the world’s first green steel bond supporting the creation of steel in an environmentally friendly way. Elsewhere we have seen the launch of the world’s first gender equality bond and the world’s first lithium mining bond – among a range of other innovative new EM issuance and products. We are genuinely excited by these new investment opportunities and are hoping to see some more of this innovation in the EM impact market in the months ahead,” he concludes.

The value of investments can fall. Investors may not get back the amount invested.