Discover more from ESG on a Sunday
Week 4: ESG in China 🐲
In this issue: ▸ ESG in the age of COVID-19 ▸ 2020: The globes and the stars ▸ ESG is struggling in emerging markets ▸ The Chinese ESG boom (and more)
I hope you are well and ready for this week’s ‘ESG on a Sunday’!
ESG in the age of COVID-19
2021 is dragging its feet across the planet, looking down at its shadow across continents, clueless about how to run from the COVID-19 pandemic which continues to take its toll on humanity with mutations, lack of truly organised vaccine campaigns (mostly in Europe and US) and the prospect of 11 more months of pain, before sister 2022 takes over.
It is what it is. And below the surface of COVID-19, in the wonderland of ESG, many things are indeed happening. However, the big questions – if ESG makes a real difference, and what the real outcome is of the trillions of dollars invested in various financial vehicles around the world nowadays – remain largely unanswered. I’ve written about that here.
What 2020 looked like from an ESG perspective is another question that needs to be addressed. Who are the leading funds, the big giants shifting financial flows into a sustainable or at least a more sustainable future? And do the letters from BlackRock CEO Larry Fink make the difference that many people think?
Yes, there are many questions to answer. And not all will be answered today. In this edition, I will focus on “2020 in ESG” and then take a long look away from ESG in EU and US and all the way to… China!
ESG funds in 2020 – the globes and the stars
Let’s begin with last year. If we want to look at it from the perspective of the biggest ESG funds and identify the best and the worst funds, then Morningstar provides us with the information here.
I can’t help looking at the underlying strategy of the leader of the ESG pack, the five-star-rated Baillie Gifford Positive Change. Its returns in 2020 were a hefty 80%.
Needless to say, the fund has beaten its benchmark: while it aims to outperform the MSCI AC World Index by two percentage points a year, it was actually ahead of it by a considerably larger 73 percentage points.
Here’s a comparison of the MSCI AC World Index and Baillie Gifford Positive Change for the past year (as of yesterday, so not 2020, but you get the picture):
What has helped the performance of that fund is having a heavily concentrated portfolio of just 31 holdings. I like this approach a lot. It shows how picking the right companies can make you reap large (financial) rewards.
However, I had a look at the “ESG outcome” of the fund. In other words, what you get in terms of better environmental risk management, lower emissions, better working conditions, more sound governance, more circular products and services when you invest in the fund. And… the answer is mostly “processes”. There are no particularly tangible outcomes. So far ESG is only a process game.
The main contributors to the performance of the fund have been electric vehicle manufacturer Tesla (you can read my ESG analysis of Tesla from last week here) and American biotech company Moderna.
Particularly Tesla, which is its largest holding, has had a stonking year and the share price has soared an incredible 800%.
But pay attention now: The fund has only 2 globes on the 5 globe sustainability rating scale provided by Morningstar.
So if you look for the globes, you might miss the stars…
ESG is struggling in emerging markets
If you look at the biggest ESG funds in the world by AUM, something a bit odd becomes clear. More or less all of them are global equity funds with a significant tilt towards US.
However, to a certain extent it’s not so strange given the construction of indices they are benchmarked with, and how poorly represented emerging markets are in this pool.
A lot of it is because reporting habits of companies in those parts of the world are not “up to” western standards and their numbers are not easy to verify. So they are not “easy to buy” for an ESG investor.
Therefore, emerging markets are penalised by the ESG community and sadly – and I really mean sadly – they do not attract ESG investors even though this is where their investments could make the biggest difference. Read more.
ESG investing in Asia
Improving ESG management in US or EU based companies has marginal leverage compared to emerging markets companies. That’s obvious.
The question is when or if this will change, and if we will we see another interpretation of what ESG means in, for example, Asia. In this piece you can learn more about some of the challenges facing ESG in Asia.
And in this one, you can learn much more about governance of ESG and emerging regulations in number of countries in Asia.
The Chinese ESG boom 🐲
If we look at the dragon land of China, ESG investing is enjoying a boom, according to the latest report from Ping An. This is happening despite the fact that the world’s second-largest economy has the worst ESG ratings of any major market.
Ping An’s report, entitled “ESG Investing in China” (available here), states that the capital flow into ESG-themed exchange-trade fund (ETF) investment in China increased by 464% between 2018 and 2019. China has benefitted from a global trend of inflows into ESG-themed ETFs, which hit a record high in 2019 of $20.5bn, four times the volume of 2018 of $4.9bn.
The report also found that ESG funds are outperforming the China market average. For ESG equity funds, since 2020, the annualised return for pure ESG funds was 47.07%, environmental-based funds 70.02%, pan-ESG concept funds 56.4% and corporate governance funds 47.91%. The annualised return rate of all ESG equity funds has exceeded the average of 42.22% for the overall equity fund market. Read more here.
Overall, the demand for ESG in China seems to be far more than just a trend. It’s really gaining ground.
The state of play in China
The Chinese asset management market is around RMB17tn (US$2.5tn). Let’s take a closer look at the state of play of ESG investing in China.
Despite gaining ground in terms of volumes, China is currently facing enormous challenges in virtually every aspect of ESG investing and disclosure. The main sources are government laws and regulations, financial supervision authorities and voluntary disclosure by listed companies. These frameworks are used to steer corporates towards more sustainability:
“The 2018 Environmental Tax Law” targeting pollution.
The Asset Management Association of China’s (AMAC) Green Investment Guidelines.
The China Securities Regulatory Commission’s (CSRC) requirements that all listed companies and bond issuers must disclose ESG risks associated with their operations.
Drivers of ESG investing in China are in many ways, and for the right reasons, different from those in more developed markets.
Corporate governance and environmental standards
The main attention of investors investing in China is paid to corporate governance issues, which in China, by business people, is seen primarily as a value creation issue. Corporate governance does not have a long history in China, and the understanding of implications related to corporate governance is still evolving.
Another issue often mentioned is environmental standards coupled with renewable energy, which in China is mainly driven by government policy. In particular, compliance with pollution regulations plays an important role – carbon emissions less so. In China, environmental issues are usually considered from the standpoint of risk management, and therefore not directly leading to alpha.
Chinese ESG data, anyone?
ESG investing depends heavily on disclosure and the availability of data. So what is the situation in China?
A number of foreign ESG data providers are now active in China, partly driven by the growing inclusion of Chinese companies in international indexes. Increasingly there are home grown providers active in the field. Some foreign providers have either invested in local companies, or cooperate with them. However, most data are very recent, hard to compare, not standardised and often hard to access.
Rating and scoring are still in the very early stages, and there is very little consensus between the different rating agencies who do operate in China. As a consequence, asset managers have to rely to a larger extent on their own research unlike what would be the case in more mature ESG markets. This means they need to put more resources into play, more people and they have to spend more time on evaluating companies they want to invest in. And that part is not so attractive yet it seems.
Chinese performance on ESG
If you want to find out how Chinese companies are performing on ESG, have a look at this. In 2019, 85% of the 300 companies in the Chinese Securities Index (CSI) released annual ESG reports. However, among those companies, only 12% had audited reports.
To put it bluntly, the Chinese communist-state-capitalism model will certainly result in Chinese communist-state-ESG interpretation, and here, in this special report, you can find out why.
While this is happening we must not forget that “big brother” (or is it just a “brother” nowadays?) on the other side of the world, the US, is making its own attempt with the new president to tackle or, let us hope, reinvigorate ESG.
That’s it for now. Have a great week!
Best regards, Sasja