When people think about environmental, social and governance (ESG) risks, they generally think about the amount of carbon emissions a company spits into the atmosphere, or how senior managers are incentivised.
However, country-level ESG risks can be just as important and move stock market prices. That’s because they can significantly impact the stability and growth potential of investments within those nations.
Here’s what investors need to know about ESG risks across developed and emerging economies and why the higher risks of investing in emerging markets can be worth taking, if you manage them carefully.
This article isn’t personal advice. Investments can rise and fall in value, so you could get back less than you invest. If you’re not sure if an investment’s right for you, ask for financial advice.
What investors need to know about ESG risks
Environmental risks
Wealthier nations usually have the resources to invest in sustainable infrastructure, clean energy and new technologies to reduce environmental risks.
Countries like Norway, Germany and New Zealand are leading the charge in switching to renewable energy sources to reduce their dependence on fossil fuels.
Developed countries tend to enforce stringent environmental regulations, thereby helping to manage risks like climate change, pollution and biodiversity loss.
Wealthier countries can also adapt better to environmental changes.
The Netherlands, for instance, has invested billions in flood defences and water management systems in response to rising sea levels. Others have developed early warning systems which help them to prepare for natural disasters, and reduce the human and economic costs.
In contrast, emerging economies are often more reliant on industries like agriculture, which makes them more vulnerable to climate-related events.
Nations in South Asia, for example, face significant risk of droughts, floods and rising temperatures, which can devastate crops and livelihoods.
Social risks
Social factors like education, healthcare, and community relations are crucial for building a healthy, motivated, and skilled workforce.
Scandinavian countries, like Sweden and Denmark, are renowned for their robust welfare systems, which help reduce risks like inequality and health crises.
Less developed countries often face high levels of poverty and inequality, exacerbating social tensions and hindering economic growth.
This instability, combined with weaker healthcare and education systems, makes these regions more vulnerable to crises and less attractive for investment.
For example, several African nations have struggled with high levels of poverty and weak public services, making it challenging to seize economic opportunities.
Governance risks
Wealthier countries typically have more established institutions and regulatory frameworks which help transparency, accountability and the rule of law.
The UK is home to one of the oldest democracies on the planet, and along with other developed economies like Switzerland, Australia, New Zealand and many of the Scandinavian countries, it often ranks among the best governed countries worldwide.
This helps create a stable and predictable business environment and attract foreign investment. Wealthier countries also have the capacity to enforce anti-corruption measures and protect property rights.
Emerging markets are often characterised by weaker institutions, corruption and political instability. These issues can create an unpredictable business environment and also lead to a vicious cycle where poor governance undermines development, worsening social and environmental problems.
In countries like Bangladesh, corruption remains a big issue and can divert resources from critical projects, while political instability hampers long-term policy implementation. It remains to be seen how ongoing political changes in the country will impact its long-term prospects.
Should you invest in emerging markets?
Emerging markets are the engine of global growth and home to some of the most dynamic economies on the planet. Investing some of your portfolio here can be a good way to help diversify.
They're hotbeds of innovation and technology is an increasingly important part of what they do. From smartphones and IT services to some of the world's biggest online shopping platforms.
However, it’s important to take steps to help minimise the additional risks of investing in emerging markets. You can do that by investing for the long term and diversifying your investments across lots of different industries and countries.
Two fund ideas
Investing in these funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio. Both funds can invest in smaller companies, which adds risk.
For more details on each fund and its risks, use the links to their factsheets and key investor information.
Legal & General Future World ESG Developed Index
For investors who don’t want to take the risk that comes with investing in emerging markets, we think the Legal & General Future World ESG Developed Index could be a good option.
This fund aims to track the performance of the Solactive L&G ESG Developed Markets Index and is made up of about 1,350 companies based across the developed world, including the United States, Japan, the UK and Europe.
The index increases or reduces the size of its investment in companies based on how they score on various ESG criteria – from the level of carbon emissions to the number of female board members and the quality of disclosure on executive pay.
It avoids investing in companies involved in controversial weapons, and those with significant involvement in tobacco, civilian firearms, thermal coal and oil sands. Likewise, for continuing violators of the UN Global Compact Principles.
The fund also aims to reach at least a 7% reduction in carbon emissions per year until 2050.
Legal & General Future World ESG Emerging Markets Index
For those comfortable with emerging market risks, the Legal & General Future World ESG Emerging Markets Index can complement the Developed Markets Index.
It applies the same investment process, but tracks the Solactive L&G Enhanced ESG Emerging Markets index, which focuses on regions like Taiwan, China, India, South Korea and South Africa.
The fund offers plenty of diversification too, investing in over 1,700 companies spanning industries like financial services, technology and pharmaceuticals.
Next week is Good Money Week, a national campaign promoting responsible investing.
We’ll be marking Good Money Week with a series of articles designed to help you invest while managing ESG risks.
To make sure you don’t miss out, sign up to our Editor’s Choice email and we’ll send you our latest expert insights and ideas from the week.
