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Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm here today by James Donald, Lead Portfolio Manager for Emerging Markets at Lazard.
Hello, James.
James Donald: Hello.
Wall: So, ESG is a hot topic at Morningstar. We're looking into the ways that good ESG can mean fantastic returns for investors and it's something that you've been applying to emerging markets for some time, isn't it, looking at how governance can help you shape investment decisions. I thought perhaps we'd start by highlighting some of the pitfalls, some of the risks investing in emerging markets to do with governance that may not exist in developed markets, in those that are more transparent?
Donald: Well, emerging markets are already a high return-return but high-risk asset class. So, you already have risks that you probably don't have so much of in developed markets, but also shareholder protection is lower. You also have control groups in almost all emerging market companies and as fragmented minority investors were at a disadvantage against those control groups.
Wall: And part of that is to do, as you mentioned there, is to do with the fact that the structure does not exist to prioritize shareholders. Now, it's getting better, but shareholders are not at the top of their priority list in emerging markets, partly because there's a lot of state-owned enterprises. I'm thinking in China, for example, where the shareholder will be not top of the companies' priorities?
Donald: Yes, I think that's right. I think it's not just states but states are important, but also local groups and multinationals and they can take advantage of minority shareholders remarkably easily if they want to and that's really what we're trying to look out for. We don't necessarily want to be the absolute priority. We want all shareholders to be treated in a fair and relatively equal way.
Wall: And how do you use governance then to inform your investment decisions?
Donald: Well, when we're interested in a company fundamentally, we'll then move on and have a look at the history of governance with the company and what we think the future will also entail. So, the history involves looking at historical abuses, whether they've treated different groups, not just shareholders but also the environment, their employee base, other entities in society, how they've treated them in the past. We think even with other elements in society there's a risk to treating them poorly.
We also look at disclosure, the company's communication with the shareholders. And then as more of a future-focused area we really tie in whether we're aligned to the management and the control group. So, we want to see that management, for instance, if possible, is encouraged through variable compensation that's logically derived, that's material and that hopefully is paid to a large degree in restricted shares because we think we're very aligned with groups on that basis. With the control group, again, it's whether we believe we're aligned with them and then finally whether it's one share one vote.
Wall: And you're not doing this to have a warm fuzzy feeling inside, because you feel passionately about ESG or you might be, but also these things go hand-in-hand with long-term returns, don't they?
Donald: We believe that governance is a major risk issue. And if companies don't treat other parties and particularly, shareholders on a relatively equal footing then you have worse relative performance over time. We can learn by investing with groups that treat shareholders relatively well and relatively badly.
Wall: And how do you use your position once you are a shareholder in a company because one of the great things about being a shareholder is you can help to positively influence that company when it comes to decision making?
Donald: Well, we almost always discuss governance with companies when we meet them and we express quite strong views on how we think companies should compensate, how we think companies should behave in certain situations. We also offer ourselves often as almost an advisor to companies in certain situations where they are concerned about a governance situation and where they might want to question an investor and see what they think about the situation themselves.
Wall: James, thank you very much.
Donald: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
