US President Biden this week invited over a hundred countries to his Summit for Democracy, which is being held on 9-10 December.
We review the democratic credentials of the main emerging countries invited and revisit the implications for investors in EM of the morality-laden rhetoric of US foreign policy under Biden.
EM investment in Biden's moral worldview
The US administration under President Biden couches much of its foreign policy in the rhetoric of human rights and democracy. This raises practical and ethical questions for investors in emerging markets.
Do negative remarks by the US administration on a country's human rights record and its democratic credentials signal a higher risk of trade and investment restrictions and, in the extreme case, sanctions? Clearly, the answer is yes.
Should an ESG-minded investor's view of whether a country meets its ethical criteria be informed by the publicly stated opinion and actions of the US administration, or indeed any third party? Here, the answer should be no.
Most investors demonstrably do not care much about democracy. Massive foreign inflows into China publicly traded equity and debt, despite this year's setbacks in the fundamental investment case, is evidence of this. Saudi Arabia, after its inclusion in the benchmark MSCI EM equity index in 2018 or Vietnam, the foreign consensus favourite small emerging market, are other examples. Indeed, at times, investors may wish for a little less democracy, as many veterans of LatAm might testify to.
In the pure, amoral pursuit of returns there is arguably no more reason why investors should care about human rights and democracy any more than they should about climate change factors, unless there is a disruptive change coming in the time horizon on which they are rewarded.
However, if institutional funds are marketed under the ESG banner, then ethics enter into the investment case. And if those funds are managed sincerely, then ethical standards should be applied to country selection as much as country selection.
US President Biden is hosting the Summit for Democracy on 9-10 December to "galvanize commitments and initiatives across three principal themes: defending against authoritarianism, fighting corruption, and promoting respect for human rights".
This week, the list of over 100 invited country participants was published. The original stated reason for issuing invitations to some countries but not others was to reach out to "a regionally diverse set of well-established and younger democracies whose progress and commitments will advance a more just and peaceful world".
Below, we screen the emerging markets in our universe on the basis of whether they are invited to Biden's summit, third-party scores of how democratic are their political systems, and how much more or less democratic they have become over the past decade on one of these third-party measures.
Including or eliminating countries on the basis of these third-party indices truly is no more valid an approach than taking the Biden administration's rhetoric as gospel. ESG-minded investors should treat those third-party metrics with caution.
There is a very high degree of subjectivity in any assessment of a country's current democratic credentials, eg the EIU scores Malaysia much closer to the US than Freedom House or V-Dem, and the pace at which those credentials are improving or eroding, eg has Bangladesh really become more democratic over the past decade as the EIU's index implies?
These scores can change very quickly and recent democratic gains, as judged by these third-parties, can be very fragile, eg the two biggest democratic gainers of the past decade, 2010 to 2020, in the EIU index are Myanmar and Tunisia, both of which have suffered major setbacks this year.
Subjectivity and lack of standardisation plague most of the ESG asset class but that reinforces why funds that market themselves as ethical should be pressed much more on how they justify including some but not other countries in their investable universe.
Deferring how the investable universe of countries is defined for ethical, ESG-minded investors to third parties is no less an abdication of responsibility than when passive funds leave it to third parties, such as MSCI or FTSE in equity or JPM in sovereign debt, to determine which countries to include.
Country ESG related reading and data
ESG needs to focus on countries, not just companies, October 2021
Indonesia signals development over deforestation curbs, November 2021
Inequality a key issue for many, not China alone, November 2021
Xi Jinping and key person risk in emerging markets, November 2021
Gerontocracy in emerging markets, October 2021
Elections that will shape emerging markets in 2022, November 2021
20 years after 9/11, War on Terror gives way to focus on China, September 2021
The Tellimer Emerging Markets Investability Matrix, available to subscribers, contains over 160 market, economic, ESG, political metrics across over 50 countries – this includes almost 20 metrics each on governance and political risk.