A structural imbalance in the way global investor capital is allocated poses a major threat to the less developed parts of the world, according to sustainable investment experts.
Private asset owners have invested over $1 trillion in infrastructure assets globally in the last 10 years, according to OECD data — but most of that capital has been deployed in developed markets.
“You’ve got to remember that 80% of the world’s capital is locked up in 10% of the world’s stock exchanges,” said Paul Clements Hunt, CEO of The Blended Capital Group, at a conference hosted by the Responsible Investment Association of Australia (RIAA).
“Our inability to find effective flows to the least developed countries is a huge growing systemic risk for the 21st century,” Clements Hunt said.
As investors evolve their asset allocation to incorporate new asset classes and a broader range of ESG considerations, the option of frontier markets has come into play. Clements Hunt said an allocation to these less developed and potentially riskier markets is not expected to be the overriding approach that asset owners take to investing, but an extension of it.
“[We’re] taking a view that a 1% allocation to frontier markets and development capital is and should be a natural part of the capital allocation process,” he said.
The World Bank identified this particular issue following the G20 meeting in 2020, and it argued that despite the top 300 pension funds in the world managing around $16 trillion, not enough was flowing to infrastructure in frontier markets and marginalised communities, where the economic benefits were massive.
For example, the country ranked lowest on the human development index, Niger in western central Africa, has not exactly been making headlines for investors. It has a population of 23 million people, and the Sahara desert runs right through it. It is also the biggest uranium supplier to France’s nuclear industry.
“By 2100, it will have 86 million people,” said Clements Hunt. “But effectively, it’s been abandoned by investors. So, whether it’s through philanthropy, blended capital flows or donor finance, we have to find a way to deliver basic services to some of these least developed countries. Otherwise, it’s a massive systemic risk.”
THE ASIA CHALLENGE
Most frontier markets in Asia — including Vietnam, the Philippines, Bangladesh and Mongolia — are competing to entice overseas investors to provide infrastructure financing for everything from agriculture and mining, to textiles and IT.
Alexis Cheang, sustainable business leader at Mercer in Australia, said many pension fund investment committees would be happy to remain uninvested in frontier markets, because they feel there’s too much risk involved.
“So there is a conundrum in that some markets are deemed uninvestable by institutions, because of governance risk largely, and capital controls. But on the other hand, the world can’t move to a sustainable future without investing in these markets. So the question is, what sort of innovative finance can we develop to try to get capital to those people who need it most?"
Sustainability bonds are a possibility, she said. “The $70 billion clean green bond market has an almost infinite capacity to expand and become a significant component of the $90 trillion annual fixed income market.”
Having offered lacklustre equity market returns right up to the global financial crisis, frontier market-focused portfolios have rewarded long term investors since then. The MSCI frontier markets index has risen from 8,500 in May 2009 to 34,500 at the end of 2021.
Ross Piper, CEO of Christian Super, said at the RIAA conference: “Everyone will have a different moral position about whether there are certain countries we should be in.” For super funds, it’s a complex issue, made only a little easier by the evidence that active ESG investors perform better than their less-engaged peers.
The RIAA’s newly published report on the relative performance of super funds found that, for the first time, responsible investment approaches are influencing strategic asset allocation for the majority of super funds (55%, up from 39% in 2019).
“This means that responsible investment is considered when allocation between different asset classes is rebalanced, to meet financial return targets, reflect risk tolerance and time horizon.”
Blended Capital’s philosophy is based on the idea that disruptive, digital technologies have the power to transform lives, communities, ecosystems and the health of the planet.
Advancements in connectivity and innovative fintech solutions are fast-tracking financial inclusion in many frontier emerging countries. Digitisation of government services and a push towards cashless societies are helping to formalise what are typically sizeable parallel economies.
“Delivering sustainable development to the 2.4 billion people at the base of the socio-economic pyramid — the marginalised of the last mile — will determine the true success of the 21st Century,” said Clements Hunt.
“By 2050, some 70% of the world’s 9.7 billion population will live in cities, and the carbon intensity of those cities will be determined by infrastructure investment decisions made over the next 15 years.”
But governments at the national, provincial and municipal levels do not have adequate fiscal resources to address the scale of the evolving low carbon infrastructure challenge, he said.
“Understanding this financial gap, it is clear that the savings of billions of ordinary citizens will need to be mobilised into productive, climate-smart infrastructure investments that meet the needs of the end beneficiaries, communities and investors.”
This includes the significant assets of rich families — approaching $50 trillion, controlled by some 10 million people worldwide — which will need to be invested in the low carbon infrastructure transition in this decade, at a time when we are seeing the biggest intergenerational transfer of private wealth.
According to Rami Sidani, head of frontier investments at Schroders, 10 years ago frontier equity investing was dominated by Middle Eastern, oil price-sensitive markets. Today, many of these have graduated to emerging markets, allowing investments to move towards a more coherent set of low-income, less-developed countries with greater exposure to export-led development.
“Most of the markets that we invest in are nascent economies that have been growing at 5%-plus per annum. A relatively low base of financial inclusion points towards the sustainability of these rates for an extended period of time,” said Sidani.
Vietnam is the largest market within the frontier emerging investment universe. It is also one of the very best structural growth stories in the developing world, he said.
Responsible investment strategies used by super funds