Morningstar Magazine - June/July 2017 - 28

Dispatches

exclude companies in certain lines of business
such as tobacco, alcohol, and gambling.

stand out among other emerging markets and also
many developed markets. Controversies mainly
concern the mining sector, which has contributed
to environmental pollution as well as human
rights infringements.

contributions toward environmental pollution
began during its Soviet-era expansion.
The country's infrastructure is archaic and has led
to employee health and safety incidents.
Meanwhile, state-owned enterprises continue
to cultivate antitrust practices and corruption.

Emerging-markets ESG filters create large
unintended country bets. Although they track
different indexes, both ETFs exhibit
significant country biases. China is the most
underrepresented country, accounting for
only 3% - 4% of each portfolio, while India, South
Africa, and Taiwan are notable overweights.
Morningstar partner Sustainalytics explains why
China trails peers across environmental, social, and
governance factors in a paper titled "Bridging the
Gaps: Effectively Addressing ESG Risks in Emerging
Markets." For one thing, China's economic
expansion and rapid population growth have heavily
contributed to environmental pollution, and
Chinese firms receive the lowest environmental
scores of all emerging-markets firms.
On the social front, China lacks adequate labor
standards and policies, and on-the-job employee
accidents occur more frequently in China relative
to other BRICs. When it comes to corporate
governance, Chinese companies' poor financial
and operational disclosures make it difficult for
foreign investors to assess security risk. Opaque
business environments also foster corruption and
bribery. Additionally, most listed companies are
government controlled entities that are particularly
vulnerable to conflicts of interest between
the government and minority shareholders.
The ESG-screened emerging-markets ETFs are
underweight Russia as well, for similar reasons.
Russian companies have failed to establish
solid environmental, social, and governance
systems. They are also among the least
transparent in the emerging markets. Russia's

Interestingly, the Taiwan stake of the MSCI
Emerging Markets SRI Index is about twice that of
the MSCI Emerging Markets Index. This is
because Taiwan Semiconductor Manufacturing
TSM accounts for nearly 16% of the MSCI
Emerging Markets SRI Index, but only 3.5% of the
broader benchmark. The MSCI Emerging
Markets SRI 5% Issuer Capped Index is in line
with the broader benchmark.

India and South Africa, on the other hand,
are among the most overrepresented countries
in emerging-markets SRI ETFs, with overweights of 6 to 7 percentage points relative to
the MSCI Emerging Markets Index. Indian
companies have a history of child labor, employee
discrimination, and corruption. However,
Morningstar research indicates that India's large IT
sector is responsible for raising the country's
overall ESG profile. Because companies like Tata
Consultancy Services TCS:IN derive most
of their revenue from Europe and the United
States, they must adhere to Western ESG
practices. India's rapid population growth
has taxed the environment, but the government
has implemented policies to reduce carbon
emissions and promote energy efficiency.

Socially responsible investors seeking access
to emerging markets need to make a trade-off
between exposure to ESG risks and country
allocation, particularly with regard to China.
Heavily underweighting the world's second-largest
economy can cause significant divergence from
mainstream benchmarks. Investors wanting
more representative exposure should consider
funds with less-stringent ESG requirements.

Under the King III code, South Africa requires its
companies to report on ESG practices. This
greater level of transparency makes South Africa

Monika Dutt is a passive strategies analyst with
Morningstar research in the U.K.

Significant Under- and Overweights in Emerging Markets SRI ETFs
Weighting:

Under

Over

%

Name

Brazil

China

India

Russia South Africa South Korea

iShares MSCI Emerging Markets SRI

7.40

3.38

14.03

1.38

11.85

15.44

23.05

UBS ETF MSCI Emerging Markets SRI

8.51

3.86

16.01

1.56

13.06

17.32

13.27

MSCI Emerging Markets Index

7.51

26.50

8.66

3.70

6.44

14.96

12.27

Source: Morningstar. Data as of 03/31/2017.

TRENDS

Q4
2014
28

Q1
2015

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2015

Q3
2015

Q4
2015

Q1
2016

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2016

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2016

Q3
2016

Q1
2017

Taiwan
Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2017
