Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
China could be a ‘game-changer’ in ESG – PineBridge
While investing following strong and integrated ESG principles does not readily spring to mind when considering China there is more action going on across the sustainability space there than many people think. The building blocks are already in place: a growing green credit market that is encouraging companies to invest in ESG-related projects, strategic government policies, and companies eager to leverage technological advances to amplify the impact.
According to a paper by PineBridge Investments, given the potential scale of ESG-driven changes at the enterprise level, investors in China will likely see ESG practices emerge as a valuable source of alpha potential over the long term.
Referring to the pro-ESG trend so far as “the tip of the iceberg”, the paper says: “With its sheer size, China has the potential to be a game-changer in global sustainability investing. Yet in China’s idiosyncratic market, these opportunities may not always be easy to discern. Therefore, a rigorous evaluation of these opportunities, informed by local knowledge and experience, will be key. In our view, sustainability should not be a point-in-time measure, but a long-term value creator – and may offer tangible benefits to investors.”
Written by Elizabeth Soon, head of Asia ex-Japan equities, Cynthia Chen, a portfolio manager for that strategy, and Arthur Lau, the head of Asia ex-Japan fixed income and co-head of emerging markets fixed income, the paper says that technology, where China has already shown some clear advantages, is likely to play a pivotal role in the transformation.
The paper is called: ‘China’s ESG Iceberg: Sustainability in the Age of Technological Disruption’. There are three key areas for investors to assess:
- Financing: capital as a lever of ESG change
- Adoption: technology as an accelerator, and
- Metrics: data as a key to identifying opportunities.
Government leadership, entrepreneurial drive and technological prowess are intersecting and potentially forming the next alpha frontier in China, the paper says. Like many other emerging developments in the Chinese economy, ESG developments may appear limited or unsystematic on the surface, but the scale and speed of transformation may indicate a much larger opportunity lying beneath.
Financing has emerged not only to develop environmentally linked sectors, such as renewable energy, but also to assist companies in traditional industries looking to ‘green’ their operations. Various government subsidies and incentives have been put in place. In 2016, seven ministries and regulators issued the ‘Guidelines for Establishing the Green Financial System’. In just four years China has become, in 2019, the world’s second-largest issuer of green bonds after the US and ahead of France, Germany and the Netherlands. The Chinese green bonds raised US$31.34 billion last year.
The majority of the money has gone to projects such as low-carbon transport, renewable energy and sustainable water. “Green financing has become an important enabler of ESG adoption – perhaps representing the tip of the ESG iceberg in China – and its rapid growth signals the extent of change still underway,” the paper says.
ESG principles can be manifest in different ways, either internally, such as improving corporate governance and better operational processes, or externally through products and services which promote sustainability in the community. The authors say: “Perhaps no other industry has exemplified the ability to do both in China better than the technology sector. With their international exposure and foreign shareholders, some Chinese technology companies are setting the tone on ESG adoption by incorporating their sustainability objectives into their business objectives.
“A Chinese e-commerce giant, for instance, focuses on seven sustainability priority areas: corporate governance, intellectual property rights, cyber security, data protection, human capital, environmental impact, and social impact. And with hundreds of millions of users, the ability to roll out new products and services quickly, and the capacity to change mass consumer behaviour, these tech companies are deepening and expanding ESG’s impact on society.”
While the authors admit that ESG investing is still in its early stages in China compared with Europe or the US, shifts in investor attitudes could speed up the trend, especially as more foreign investors buy into the China A-shares market and a new generation of ESG conscious Chinese investors emerges. But, as with other countries, access to information, lack of standardisation and imperfect transparency hinder the application of ESG principles.
The paper quotes from a case study of a Chinese investor, Chibo Tang of Gobi Partners China, which specialises in technology startups, who says that ESG by its nature is difficult to quantify and measure. Traditional metrics, such as financial indicators, do not paint the full picture. “Data that can be used to evaluate ESG performance is difficult to collect and analyse – only the application of technology can provide the tools and frameworks with which to do so. There are many startups spread across various industry sectors utilizing AI, blockchain, cloud solutions, connected devices, and more to address either very specific industry problems or broader ecosystem issues,” Tang says.
– G.B.
