Only 15% of the world lives in developed countries, yet these countries represent over 40% of the world’s GDP. However, this is likely to be transformed in the near future. Various estimates are predicting that by 2030, the middle class will reach 5.6 billion people, which translates into 2 billion people with increased purchasing power, 87% of whom are Asian. India and China combined will represent 66% of the global middle class in just over a decade.1
Most of the emerging countries see the developed markets as an aspiration and understandably want to be part of the growing middle class. We, and other emerging markets investors, consider this a great opportunity. We love talking about the low penetration of various consumer products and long-term secular growth prospects as these markets grow in wealth and size. While the narrative of investing in the emerging markets sounds promising, there is a simple question that investors often forget to ask — what is the negative impact of these positive improvements? We know from the evolution of the developed world that our benefit has come at a cost to the environment. As it stands, we remain the largest environmental offenders from a per capita perspective. Reflecting on the per capita element, the fact that by far the majority of the world’s population resides in the emerging markets and wants a higher standard of living will inevitably worsen the environmental crisis we face.
Emerging markets will require more energy output as they become more power-hungry, leading to more power plants fueled largely by coal given its abundance and low cost of extraction. The inevitable result is larger carbon emissions and air pollution. These consumers will also require more factories, producing short-lived consumer products that will lead to plastic and other types of waste that are likely to end up polluting land and oceans or in our food systems through micro plastics. This is just the tip of the iceberg for the environmental damage that is taking place as billions move closer to becoming middle-income citizens.
For us it is clear that the developed world cannot expect the emerging world to curb their middle-class aspirations in exchange for cleaner water and air. A new approach is required, one where economic progress is not solely calculated based on traditional revenue or EBITDA metrics but also on whether companies are operating in a sustainable2 way to actively minimize their negative impacts, while providing products and services that are improving the quality of life for the masses. Specifically, for the Responsible Global Emerging Markets strategy, we look for companies that have a positive impact by either solving, or being positioned to benefit from, the sustainability challenges in the emerging markets.
In our investment universe, we regularly observe some emerging nations that go two steps forward and one step back in terms of economic development, while others have progressed more steadily — among the latter group is China. China as a nation has done a tremendous job of lifting its large population into the middle class from poverty. China today leads the world in the number of internet users and college graduates and is working to land a person on the moon. It is fair to say China is no longer the sleeping giant portrayed by Napoleon Bonaparte. This success has a cost, though. The ecological environment of this 1.4 billion strong nation, who today eat three times as much meat as in 1990 and consume five times more dairy than in 1995, is faced with declining farmland, where 20% of what remains is polluted and there is visible air pollution in cities.3 Many other challenges are highlighted regularly in the media.
While it is easy to be pessimistic about the future of China with all the negative news that is regularly flagged to us, we remain optimistic that over time they will overcome these challenges. There is a lot of progress that often doesn’t make front-page news. For example, China spends three times more on renewable energy than the U.S. It is also by far the largest investor in this field globally, with renewables expected to reach 35% of China’s energy mix by 2030, up from 12% just 4 years ago.4 82% of Chinese consumers are willing to spend more on healthy food and beverage products, much higher than the global average of 68%.5 To keep the ‘social contract’ between the leadership and the people intact, there is a requirement to change and improve. We are already seeing this and are likely to see more. In other emerging markets, we are seeing countries heavily investing in renewables, banning plastic bags, implementing a tax on sugar — basically taking the social cost from the public and forcing it into the accounts of the corporates. We welcome this and, equally, we demand our companies to prepare for and, where possible, benefit from these challenges.
Investment case study
Vitasoy (healthy food and beverage producer) demonstrates a number of the qualities we look for in a business. It effectively works towards addressing upcoming sustainable development challenges: it has invested to mitigate the environmental impacts of its packaging and in product R&D to benefit from the structural shift towards healthier products with less sugar and fat.
The health element was part of the foundation of Vitasoy’s creation. Its history begins in Hong Kong in the 1940s, when it was established by KS Lo. He started his business with the intention of fighting malnutrition of the refugees fleeing the civil war in China, after noticing that many immigrants, who came to Hong Kong from mainland China, were also lactose intolerant. After learning about the benefits and efficiency of soybeans, he started Vitasoy to provide cheap protein and nutrition to the masses. Today, Vitasoy is one of the leading plant milk manufacturers in Asia. We like the following aspects of the investment case:
- Vitasoy has a net cash balance sheet, high return on invested capital and has revenue and profits growth of more than 20% year on year, mainly driven by its operations in China, which today makes up 57% of sales. We see Vitasoy as having a long runway of growth ahead, backed by an increase in health awareness and the increasing appeal of plant-based beverages that are nutritious and reasonably priced.
- There is also a good balance between family oversight and a proven management team — the Lo family is still active at the board level and the management is professionally run. The CEO is an Italian executive who formerly worked for P&G and Coca-Cola China.
- Vitasoy has set 2026 targets to improve its sales of plant beverage offerings to 90% (currently 89.5%), increase low-fat products to 93% (currently 92%), increase beverage offerings with moderate to zero sugar levels to 82% (currently 68%) and ensure more than 90% of their packaging is responsibly sourced (already exceeds the initial goal and currently at 91%).
- We like the fact that soy is a very efficient source of protein that contains essential amino acids and is high in nutrients such vitamin B, calcium and other minerals, while also having no cholesterol. At the same time, various pieces of research suggest soy is eight times more efficient in usable protein per acre of farmland relative to meat.6
Thinking holistically about the business implies decision-making that is based on the long-term well-being of all stakeholders and not only shareholders. Our belief remains that consumers in Asia, particularly in China, will continue to demand healthier and more environmentally sustainable products. This growing demand will provide additional tailwinds for Vitasoy, which is why we plan to remain shareholders in this business for many years.
Vitasoy is a great example of a company that goes beyond just causing the least amount of harm to society and the environment; it is much more about the responsibility it takes, demonstrated by producing products that benefit the customer and at the same time provide an environmentally friendly alternative. We believe ‘living and breathing’ being responsible to society and accountable to stakeholders is the key element for the long-term financial success of any company.
While we think Vitasoy is running ahead of its competitors as discussed above, we believe in being active owners and partners with the businesses that we invest in, and therefore see engagement for continuous improvement as part of our responsibility as shareholders.
We spoke to the CFO and the head of sustainability to gain a better understanding of the company’s approach to tackling key sustainability risks. We expressed our support for management’s commitment to incorporate material environmental and social considerations into the business strategy, as well as the significant progress made over the last few years in improving resource efficiency and the nutritional profile of some of Vitasoy’s brands. At the same time, we noted gaps in the management of environmental, social and governance (ESG) risks in raw material sourcing and encouraged the implementation of stronger practices to identify and manage such risks, particularly those related to climate change in the soybean supply chain. Overall, we believe the company is well positioned to manage the risks and capture the opportunities linked to long-term sustainability issues.
We met with the incoming president of the company, Mr. Jan Dunning. Mr. Dunning recently assumed this new role, which was created to oversee management, build a new organizational culture and lead communication with investors. Based on his previous experience as the leader of a major Russian retailer and our conversation with him, we are cautiously optimistic that he can succeed in his objectives. We adamantly stressed the importance of empowering the board and building a strong relationship with its members. Going forward, we will closely monitor any changes in the composition of the board at the 2019 AGM and seek opportunities to engage with directors to assess the board’s appetite and ability to achieve alignment of interests amongst all shareholders when it comes to capital allocation decisions.
Bank Mandiri and Bank Rakyat
We wrote to both Indonesian banks to start a dialogue on their approaches to managing the credit and reputational risks embedded in their portfolios of loans to companies in the palm oil industry. While the industry has come a long way in addressing the environmental and social impacts of palm oil cultivation, there continue to be areas for significant improvement. The letters were co-signed by six other international investors.
1https://ec.europa.eu/knowledge4policy/foresight/topic/growing-consumerism_en; ‘middle class’ defined as earning $11 to $110 per day, can expect to live a decent life and have escaped extreme poverty. They are also known as the ‘consumer class,’ the group whose demand powers most economies.
2Avoidance of the depletion of natural resources in order to maintain an ecological balance.
3Coal is still around 2/3 of the energy source for China.
4Source: U.S. Energy Information Administration and https://asia.nikkei.com/Spotlight/Cover-Story/China-s-renewable-energy-surges-after-state-backing