A few years ago, before launching our freedom-weighted emerging markets index, I was in a coffee shop where I overheard a group of students talking at the next table. They were anxious about an upcoming presentation before a panel of experts and felt out of place and underqualified.
I could relate.
In the end, they decided to present a dissenting view on the subject, even though the experts might disagree. I admired their courage and told them that there is value in new and different perspectives. Before they left, one of them handed me a piece of paper. On it was a drawing with the words:
In plain English, this fund markets itself as being committed to environmental, social, and governance principles even as it pledges to be no more than 1% different than a fund that makes no such claims.
The practice of chaining a portfolio tightly to a passive benchmark, often described as benchmark hugging (or “closet-indexing”), is common among ESG strategies. But it’s especially jarring in emerging markets, where most benchmarks allocate more than 40% to countries with very poor human rights records. By design, a benchmark hugging fund will mirror that allocation, something ESG investors would likely prefer to avoid.
In developed markets, where rights are better protected, ESG data tends to be reliable, transparent, and widely available. With freedom of speech and press, the data is accountable to the public and the media. That makes it easier to track, analyze, and compare ESG metrics.
But in emerging markets, rights are not guaranteed. Many emerging markets lack the basic freedoms we take for granted in the developed world. As a result, data provided by companies in relatively less free countries are less reliable and not subject to independent verification by the public or the media.
Countries that protect the freedom of their citizens provide the conditions necessary to support all other ESG factors. Freer countries tend to have better environmental protections, higher life expectancy, higher gender equality, lower poverty rates, and lower economic inequality. It all starts with freedom. Without the foundation of freedom in place, conventional ESG factors become less relevant to investors seeking to align their portfolios to their values, and less useful as a tool by which to measure the impact of their investments. Benchmark hugging prevents conventional emerging markets ESG strategies from fully delivering on their mission. Investors who don’t just want to “check the box” would benefit from more comprehensive measurement tools to give them a better idea of the impact their investments have on the issues they care about.
The students at the coffee shop had it right, you can’t make a difference if you’re not different. A freedom-weighted index solution reduces both ESG risks like human rights concerns and non-ESG risks like corruption and fraud that often deter investors from emerging markets. But with or without additional ESG metrics, it gives investors exposure to a freer country set that is very different from typical benchmarks. Now, nearly two years into our launch, the thing I’m most proud of is providing a first-of-its-kind, differentiated solution for investors who value freedom and want their emerging markets portfolios to reflect that. We’re making a difference by being different.
In the end, they decided to present a dissenting view on the subject, even though the experts might disagree. I admired their courage and told them that there is value in new and different perspectives. Before they left, one of them handed me a piece of paper. On it was a drawing with the words:
I was reminded of that message recently when reading the investment brief for one of the largest emerging markets ESG funds in the US. According to the brief, the fund seeks to maximize its ESG score while, “maintaining target tracking error of 100 basis points [1%].”“You can’t make a difference if you’re not different.”
In plain English, this fund markets itself as being committed to environmental, social, and governance principles even as it pledges to be no more than 1% different than a fund that makes no such claims.
The practice of chaining a portfolio tightly to a passive benchmark, often described as benchmark hugging (or “closet-indexing”), is common among ESG strategies. But it’s especially jarring in emerging markets, where most benchmarks allocate more than 40% to countries with very poor human rights records. By design, a benchmark hugging fund will mirror that allocation, something ESG investors would likely prefer to avoid.
In developed markets, where rights are better protected, ESG data tends to be reliable, transparent, and widely available. With freedom of speech and press, the data is accountable to the public and the media. That makes it easier to track, analyze, and compare ESG metrics.
But in emerging markets, rights are not guaranteed. Many emerging markets lack the basic freedoms we take for granted in the developed world. As a result, data provided by companies in relatively less free countries are less reliable and not subject to independent verification by the public or the media.
Countries that protect the freedom of their citizens provide the conditions necessary to support all other ESG factors. Freer countries tend to have better environmental protections, higher life expectancy, higher gender equality, lower poverty rates, and lower economic inequality. It all starts with freedom. Without the foundation of freedom in place, conventional ESG factors become less relevant to investors seeking to align their portfolios to their values, and less useful as a tool by which to measure the impact of their investments. Benchmark hugging prevents conventional emerging markets ESG strategies from fully delivering on their mission. Investors who don’t just want to “check the box” would benefit from more comprehensive measurement tools to give them a better idea of the impact their investments have on the issues they care about.
The students at the coffee shop had it right, you can’t make a difference if you’re not different. A freedom-weighted index solution reduces both ESG risks like human rights concerns and non-ESG risks like corruption and fraud that often deter investors from emerging markets. But with or without additional ESG metrics, it gives investors exposure to a freer country set that is very different from typical benchmarks. Now, nearly two years into our launch, the thing I’m most proud of is providing a first-of-its-kind, differentiated solution for investors who value freedom and want their emerging markets portfolios to reflect that. We’re making a difference by being different.
About the Author: Perth Tolle
Perth Tolle is the founder of Life + Liberty Indexes and creator of the Freedom 100 EM Index (FRDM Index), the world’s first freedom-weighted emerging markets equity index strategy.
Prior to forming Life + Liberty Indexes, Perth was a private wealth advisor at Fidelity Investments in Los Angeles and Houston. Prior to Fidelity, Perth lived and worked in Beijing and Hong Kong, where her observations led her to explore the relationship between freedom and markets.
Perth is a frequent speaker at investment industry events and provides commentary for various financial media including Barron’s, Bloomberg, CNBC, Cheddar, and MarketWatch.
Perth was named one of the Ten to Watch in 2020 by Wealth Management Magazine for her work on freedom investing.
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