Amid significant headwinds in 2022, environmental, social and governance (ESG) funds saw their first net outflow since 2011. However, the energy transition, climate-related threats to food security and the search for long-term value could prompt a resurgence of sustainable investment in emerging markets. Global ESG funds enjoyed a record run from 2019 to 2021, growing by 98% and seeing net inflows of $25bn in 2020 and $35bn in 2021 net outflows from ESG funds in 2022 tallied $13.2bn by November. The 10 largest ESG funds posted double-digit losses during this period, with eight of them underperforming the Standard & Poor’s 500, which was down 14.8%.

Undervalued Assets

As of early 2023 several major investment houses, including US investment bank Goldman Sachs, had grown notably more sanguine about making targeted investment in ESG companies in emerging markets that are not listed on the stock exchanges of developed markets. The absence of listing is attributed to the scarcity of available data, which can influence the ratings of these investments.

Companies in emerging markets tend to have lower ESG ratings than their developed market peers, according to MSCI, one of the world’s largest providers of ESG ratings. In early January Goldman Sachs invested $1.6bn of client capital in the Horizon Environment & Climate Solutions I private equity fund, which is listed as an Article 9 product, meaning that it complies with the EU’s toughest ESG standards.

Another reason for optimism about ESG investment is the rebound in emerging markets equities, fuelled by optimism about slowing US inflation and a coming rebound from China, which experienced an economic slowdown in 2022 due to its zero-Covid-19 policy. In January 2023 emerging market stocks hit six-month highs after enjoying eight straight days of positive performance, marking the longest streak since November 2021, buoyed by the announcement the same month that US inflation had slowed.

Energy & Climate Imperatives

Due to Russia’s ongoing invasion of Ukraine and persistent disruptions to global supply chains, numerous countries have turned to hydrocarbons or coal as a means to alleviate energy supply shortages.

In 2022 hydrocarbons-producing countries reaped record revenue on the back of high oil and gas prices. However, the case for shifting to cleaner energy sources has only grown more urgent amid what the International Energy Agency has deemed a global energy crisis. As governments adopt new policies to boost investment in clean energy and efficiency, there are tremendous opportunities for emerging markets that embrace the technologies and sources that will shape the future energy mix, enhancing the case for ESG investment. From a strictly emissions-reduction perspective, national oil companies have perhaps the largest role to play due to their dominance in production, ample reserves and cost advantages.

In the Gulf, Saudi Arabia’s Aramco, Abu Dhabi National Oil Company (ADNOC) and the Kuwait National Petroleum Company produced 19.3% of global oil and held 28.7% of proven oil reserves in 2021. QatarEnergy produced 4.4% of the world’s gas and held 13.1% of proven gas reserves. By reducing emissions and adhering to stricter ESG guidelines, the energy giants could help their countries meet their climate goals.

Aramco and ADNOC are deploying artificial intelligence to make their operations more efficient, monitor and reduce CO₂ emissions and integrate green energy resources. Recent spikes in climate change-driven drought and flooding have led to food shortages in some emerging markets, making it imperative to adopt climate-change resilient food and agricultural systems.

Sub-Saharan Africa alone will require $15bn in annual investment to support climate change-resilient food and agriculture systems, according to a 2021 report by the Global Centre on Adaptation, which estimates the cost of inaction could be as high as $201bn per annum.