Improving sustainability in Asian investments

The Panel

• David Lai, Partner and Co-CIO, Premia Partners
• Isabelle Millat, Head of Sustainable Investment Solutions for Global Markets Activities, Societe Generale Corporate & Investment Banking

With firms increasingly concerned about the social impact of their investments, they are taking environmental, social and governance (ESG) factors into consideration. In a forum sponsored by Premia Partners and Societe Generale, market practitioners examine the key topics, including whether this increasing consideration of ESG factors suggests the industry had previously been operating in an unsustainable way and what investors should consider in their approach to ESG investing in Asian markets.

What are responsible investments, and how has demand for them changed in recent years?

David Lai, Partner and Co-CIO, Premia Partners

David Lai, Premia Partners: Traditional responsible investments represented an investment style that used positive and negative screens to adjust a portfolio based on social, moral, ethical and religious criteria, and it could exclude companies deriving a certain percentage of their revenue from areas such as gambling, weaponry, alcohol and tobacco. As the concept of responsible investments evolves, it is incorporating environmental, social and governance (ESG) factors into investment decisions. It involves a proactive and comprehensive review of a company to provide a more robust image of its operations and social – as well as economic – impact. Investors basically want to look at both social and financial returns on investments. Interestingly, a study conducted by Nielsen shows that millennials and baby boomers are willing to pay extra for sustainable offerings, and indicates a growing global and cross-generational interest in companies that promote sustainability.

Isabelle Millat, Societe Generale: Responsible investments are those that incorporate ESG criteria in the selection process.

There are many ways to use ESG criteria in investment decision-making. Responsible investment is a term that usually refers to investment portfolios that take into account at least one ‘E’, ‘S’ or ‘G’ angle or exclude certain activities viewed by some investors as unethical – such as weapons, tobacco or alcohol. At Societe Generale, we prefer the term ‘sustainable investment’ to encompass all approaches to ESG, including the positive selection of ESG themes.

Global demand has increased sharply, growing from $18 billion of assets under management (AUM) in 2014 to $23 billion in 2016, according to the Global Sustainable Investment Alliance’s Global sustainable investment review 2016. A key driver for this growth is that research papers and empirical evidence have demonstrated that ESG criteria are material to financial performance – so that responsible investors can do both good and well.

Between 2014 and 2016, the retail versus institutional market share doubled from 13% to 26%, according to the Global sustainable investment review 2016. This has been made possible by the development of exchange-traded funds (ETFs) and structured products that combine an ESG theme with the financial characteristics that retail investors look for – capital protection, in particular. Societe Generale has worked with its asset management subsidiary, Lyxor, to launch ETFs such as the World Water Fund, and has distributed the Finvex ESG indexes since 2013, notably in capital‑protected notes sold to institutional clients and distribution networks.

 

What are the key ESG factors investors should be looking at in Asia?

David Lai: In principle, ESG factors should not be significantly different in Asia than in the rest of the world – environmental factors are climate change, greenhouse gas emissions, resource depletion, waste pollution and deforestation. Having said that, some ESG issues may carry more short-term weight to reflect variations across jurisdictions, cultures and developmental stages. The most prominent environmental concern is the deterioration of air quality in certain capitals – such as Beijing and New Delhi – and the resulting macro-government policy impact on equity markets. It would not be unreasonable to monitor and overweight companies’ contribution to global warming in Asia ESG screening.

Isabelle Millat: As with other areas, the materiality of environmental and social indicators for financial performance varies depending on the industry, while material corporate governance indicators are more common across industries. Investors should also look at ESG factors that match the environmental or social impacts they want to achieve.

 

Does this focus on sustainable investment mean the industry had previously been operating in an unsustainable way?

Isabelle Millat, Head of Sustainable Investment Solutions for Global Markets Activities, Societe Generale Corporate & Investment

Isabelle Millat: It means investors are now increasingly considering sustainability in their investment decisions. This is driven by proof of the financial materiality of ESG criteria, and is made possible by increased reporting from issuers – providing robust and reliable data, which is essential to the sustainable investment selection process. 

David Lai: It would be more appropriate to say that awareness of sustainable investment is increasing. Even in the eighteenth century, The use of money, a sermon by John Wesley, one of the founders of Methodism, outlined the basic principle of social investing – not harming your neighbour through your business practices and avoiding industries such as tanning and chemical production, which can harm the health of workers. In the late 1970s, activism increasingly focused on nuclear power and automobile emissions control. The industry is adjusting gradually and turning sustainable investment into a structured and systematic approach that investors can follow more easily.

A survey by Longitude Research and State Street Global Advisors reveals that Asia-Pacific investors are ahead of their global peers incorporating active ownership as part of a comprehensive ESG strategy. Around 80% of respondents from the region have some level of ESG engagement with the companies in which they invest, compared with 70% in the US and 58% in Europe. Despite increased adoption of ESG strategies by Asia-Pacific institutional investors, the findings show that the share of their portfolios with ESG exposure remains low. Only 15% of respondents in Asia‑Pacific have more than half of their assets exposed to ESG factors, compared with 27% in the US and 17% in Europe. Going forward, we expect awareness and exposure to ESG factors to rise in Asia‑Pacific. ESG exposure can transform investors’ long-term financial results, risk mitigation and exposure to volatility.

 

What questions should investors ask about their approach to ESG investing in Asia?

Isabelle Millat: They should first determine what their priorities are – which tracking error they are willing to accept to improve the ESG risk profile of their portfolios or whether they have a strong value-based or ethical driver to adopt sustainable investment, for example. This will help them choose between diversified best-in-class strategies, where they maintain sector diversification and favour the best ESG issuers in each industry, or exclusion approaches where they disinvest in companies that they – or their end-users – consider controversial.

 

Do we currently have the data we need to properly incorporate ESG factors into the investing process in Asia?

Isabelle Millat: There has been significant improvement in recent years but, as elsewhere in the world, it’s always a work in progress. Global initiatives aiming to broaden and harmonise reporting among issuers will strongly support future improvements.

David Lai: Challenges inhibiting greater ESG adoption in Asia-Pacific include cost, limited demand from stakeholders, and lack of internal knowledge and capability. Certainly, data availability is a major obstacle in implementing an ESG strategy in Asia. Data in the public domain is usually insufficient, and data based on self-reporting or questionnaires may be inaccurate or incomplete. Regulators and industry consultants are encouraging companies to increase ESG disclosures. For example, the Taiwan Stock Exchange mandated sustainability reports for large companies and certain sectors with the goal of expanding to around 90% of members by market cap before the end of 2017. The Hong Kong Stock Exchange strengthened its standard ESG guidelines in 2016.

 

What future ESG trends should investors be thinking about?

Isabelle Millat: They should watch for new trends that are going to reshape the market, and how issuers and investors communicate on impact. In that sense, the UN’s 17 sustainable development goals are becoming common vocabulary in the sustainable investment space. Societe Generale has created a range of positive impact finance notes, whereby the bank commits to holding an amount in positive impact finance assets equivalent to the nominal amount of the notes. Positive impact finance aims to deliver a positive contribution to one or more of the three pillars of sustainable development – economic, environmental and social – once any potential negative impacts have been identified and mitigated. The UN’s sustainable development goals are in line with the three pillars of sustainable development; thus positive impact finance is a way of supporting these goals. The positive impact finance notes have been sold to retail and private wealth networks, as well as to institutional clients in Europe.

Investors should also think about asset class diversification and the growth of ESG in the fixed-income space.

In approaching sustainable investment, investors in Asia should pay particular attention to the trend set by Japan’s Government Pension Investment Fund, which places a strong focus on engagement initiatives in which investors use their shareholder power to push companies towards the best ESG practices.

David Lai: An interesting trend is ESG development in the ETF space. Currently there are around 50 ETFs incorporating ESG factors globally with AUM of $4.5 billion, which is about 0.1% of the entire ETF market. Taking the largest (AUM of more than $500 million) as examples, they performed mostly in line with the market. 

ETFs, given their listed status, tradability and transparency, could help spread the ESG concept beyond institutional investors to the general public. For example, CalSTRS, the second-largest pension fund in the US, is looking to invest in companies that promote gender diversity, as research shows that those with at least three female board members outperformed others in overall return on equity by more than 36%. Despite these findings, US women account for an average of just 16% of executive teams. Instead of implementing this particular strategy through a segregated account, CalSTRS provided the seed capital and packaged it into an ETF to attract more investors to engage with ESG issues.

In Asia, the strongest private sector advocates for ESG are often family offices with long-term focus and impact-investing interests. They are often early advocates and, instead of purely implementing for their own investment mandates, many take an interest in initiatives that raise public awareness with the objective of socialising and popularising ESG development. ETFs are a perfect public tool for such investors, but are limited in scope within Asian markets. To address this, both the demand and supply sides of the ETF industry must move in tandem to fast track the process. Sales leaders and product strategists with strong technical backgrounds will have to work together to build this space in the coming years.

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