Most investors need little persuading that emerging markets offer exciting opportunities. The emerging-market (EM) corporate bond market in particular presents a tantalizing prospect for investors: Its size and strong historical performance make it impossible to ignore.
But emerging markets also pose significant and complex challenges. Some challenges—such as inconsistent regulations and a lack of standardization across countries—reflect the diverse nature of emerging markets. But others, such as the seemingly intractable problems of pollution and corruption—are ESG risks.
These risks can be material. Our analysis shows that, from 2016 through 2021, two-thirds of the worst-performing credits in the J.P. Morgan Corporate Emerging Markets Bond Index (CEMBI) were those with weak ESG practices.
Take NMC Healthcare, a private healthcare provider based in the United Arab Emirates. NMC Healthcare illustrates how governance risk can adversely affect investors. The company understated its borrowings by US$4 billion over several years. When the extent of its poor governance came to light in 2019, it was placed in administration and bondholders suffered an 80% loss. Similarly, Chilean coal-fired power company Guacolda Energia saw its bond price—and bond ratings—plunge when it resisted diversifying away from coal toward renewable resources, which led to difficulty securing long-term contracts. Investors who can thoroughly assess a company’s ESG risks can get ahead of such bad news.