When investing in Emerging Markets (EM), environmental, social and governance (ESG) factors can play a significant role in identifying growth opportunities, in addition to their more conventional role in helping to mitigate risk and enhance companies\u2019 ability to deliver long-term, sustainable returns.<\/p>\n
To illustrate how this works in practice, we asked the RBC Emerging Markets Equity (RBC EME) team to explain their approach to Marico Ltd., an Indian consumer staples company. This RBC Global Asset Management (RBC GAM) investment team is based in London, UK and manages over US$8 billion in emerging markets equities. The team\u2019s disciplined investment process considers a broad range of factors and incorporates a strong belief that a company\u2019s ESG record must be analysed in order to truly gauge the company\u2019s overall potential for investment portfolios.<\/p>\n
Marico is a leading Indian consumer staples company that operates in 25 EM countries. It has developed several brands in the hair and skin care, edible oils, health foods and male grooming categories. Its biggest and most famous products being Saffola edible oil and Parachute coconut hair oil.<\/p>\n
When the RBC EME team researches a company such as Marico, they begin by reviewing annual reports and financial statements before meeting with the company and carrying out detailed valuation work. When it comes to valuation, the RBC EME team concentrate more on cash flow-based valuation than short-term measures like price-to-earnings or price-to-book.<\/p>\n
According to the team, companies that pay attention to ESG factors and stakeholder relationships tend to have higher \u2013 and more sustainable \u2013 returns over time.<\/p>\n
The next step in the evaluation process is the \u2018investment checklist,\u2019 which is the key tool for the integration of ESG factors. The checklist has 75 questions divided into three sections: franchise, management quality and corporate governance. The questions are extremely detailed, with approximately two-thirds of the questions related to ESG and sustainability. The checklist is a way to thoroughly understand what motivates a company\u2019s management in terms of its culture, ESG and long-term sustainability, while helping to ensure that the team does not overlook any potential risks. Companies receive a score between 0 and 100 and most companies owned have a checklist score greater than 80.<\/p>\n
The questions have a long-term focus and, therefore, scores tend to remain stable over time. Additionally, there is a high correlation between a company\u2019s checklist score and its ultimate weighting in the portfolio.<\/p>\n
Marico\u2019s company philosophy, \u201cbe more, every day,\u201d was created to sustainably transform the lives of all of its stakeholders. This focus on stakeholders is a crucial component in the RBC EME team\u2019s analysis and, accordingly, many of the checklist\u2019s questions relate to how a company treats its various stakeholders.<\/p>\n
Marico\u2019s most unique feature is its strong relationships with suppliers and farmers. Marico\u2019s \u2018Farmer First\u2019 policy is a key corporate social responsibility initiative. Agricultural produce forms the majority of Marico\u2019s raw materials and consequently, implementing initiatives to improve farmers\u2019 well-being drives Marico\u2019s sustainability efforts. Marico\u2019s engagement with agricultural producers has empowered farmers to strengthen their production systems and increase yields on a sustainable basis. These initiatives are directed primarily towards India\u2019s coconut and safflower growers.<\/p>\n
Edible oil is Marico\u2019s key product, with roughly 20% of total sales attributable to Saffola Edible Oil and over 60% market share in India. Safflower seeds are the key ingredient and Marico is India\u2019s largest buyer with 32,000 farmers under contract.<\/p>\n
The checklist asks if a company\u2019s processes emulate best practice and encourage the improvement of industry standards. Marico scores well in this category. Its representatives collaborate with farmers to improve crop cultivation and offer technical guidance throughout the crop cycle. Regular seed-sowing classes are taught by selected farmers to spread \u2018best practices\u2019 to other local farms.<\/p>\n
The checklist also questions \u2018cutting corners\u2019 in production (e.g. using poor quality materials, or not paying suppliers enough). There is no evidence of this at Marico. The company ensures that good quality sowing seed is available to its farmers and its model contract provides farmers with a guaranteed, predetermined \u2018fair price\u2019 for seeds; it offers market rates whenever prices rise, and a guaranteed price should they fall. Marico has been instrumental in the introduction of new technology for safflower production and, consequently, has improved productivity.<\/p>\n
Thanks to these initiatives, farmers have significantly improved the seed replacement rate resulting in a 2 percentage point increase in oil content from 29.5% in 2011-2012 to 30.15% in 2015-2016. Any increase in the percentage of oil content leads to a significant increase in farmers\u2019 incomes.<\/p>\n
Marico generates more than 30% of its revenue from its Parachute coconut oil product, India\u2019s leading brand, with more than 50% market share in India. Marico has developed robust relationships with coconut farmers by showing them how to increase productivity and create long-term crop sustainability and higher returns. The checklist asks whether or not a firm\u2019s culture is innovative and Marico has scored well with its supply chain innovations. Over the last 10 years, collection centres have been set up within a 20-30 kilometre radius of the farms so that small farmers can supply Marico directly. This reduces transportation times and provides farmers with a guaranteed buyer for their produce.<\/p>\n
Marico also provides guidance on how to produce coconuts of the right quality that will receive the maximum price, and how to automate the dangerous and lengthy process of harvesting and drying coconuts and extracting the oil. Those farmers who adopted Marico\u2019s best practices early have seen an improvement in productivity of up to 20%, and to date the program has benefitted approximately 7,700 coconut farmers.<\/p>\n
The example of Marico and, in particular, its Farmer First policy, demonstrates how important effective management of ESG factors can be in reducing risk, and building a foundation for sustainable long-term growth in EM equities.<\/p>\n
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