At the beginning of every Chinese New Year, AsianInvestor makes 10 predictions about the economic, political and financial developments that are likely to have an impact on the way institutional investors assign their money.
Our latest Year of the Pig outlook looks at the level of engagement that asset owners in Asia have for environmental, social and governance (ESG) investing.
Will Asian asset owners treat ESG as more than a box-ticking exercise?
Answer: No (mostly)
'ESG' – namely environmental, social and governance standards – is increasingly becoming part of the mainstream investment parlance. Fund houses, consultants and asset owners all understand the concept of considering environmental needs or well-managed companies when investing.
But there is a big leap from knowing what the acronym stands for, and actively implementing ESG into portfolios. Across the region, several large asset owners are ESG advocates and have integrated the principles into their investment processes and strategies.
Japan’s Government Pension Investment Fund (GPIF) is the biggest participant and assesses all external fund houses by their commitment to ESG. According to the Responsible Investment Association of Australia, 81% of Australian super funds have some form of responsible investing commitment in place, including market leaders such as AustralianSuper, Cbus, Colonial First State and Hesta.
In addition, New Zealand Super has drastically cut its portfolio’s carbon emissions, Malaysia’s KWAP and Employees Pension Fund have committed to considering ESG factors, and in January Thailand’s Government Pension Fund signed up to the United Nations Principles of Responsible Investment (PRI).
Signing up to the UN PRI acts as an asset owner or fund manager’s public pledge to ESG, and 66 Asia Pacific institutional investors have done so to date. This engagement is heavily clustered among investors in Australia (35), Japan (17) and New Zealand (8).
Just six asset owners outside these countries are signatories, and none are based in China (the region's biggest economy) or Hong Kong and Singapore (two of its main financial centres).
Outside of these signatories, few asset owners treat ESG as anything other than a feel-good concept or something to be ignored.
“ESG is largely in its infancy in many markets in Asia,” an investment industry expert focused on ESG matters said. “There are strong supporters in some markets but many investors haven’t really engaged yet.”
Indeed, many asset owners have yet to even seriously consider ESG, let alone treat it as a box-ticking exercise. Some are suspicious, believing that it equates to pursuing environmental investing, which has a deleterious effect on investment returns.
“It’s hard to be a pension fund head and tell your members you are pursuing environmental investing but that it will have a 5% impact on their pension,” the expert said.
ENGAGING WITH ESG
Yet many studies – including a meta-study of 2,000 empirical studies on ESG by Friede and Busch in 2015 – suggest that following ESG principles has a neutral or slightly positive impact on portfolio returns.
And from a risk-adjusted perspective, taking an ESG-integration approach, in which companies are assessed on their respective commitments to ESG, returns can be greater.
After all, analysing ESG factors helps investors to understand which companies prioritise diversity of employees and board, which score poorly for environmental issues when the reputational and regulatory risks are rising, and which take minority shareholder rights or transparency seriously. That information can help investors reduce risks in their investments.
For the immediate future the idea of ESG is likely to grow among Asian asset owners, but only slowly. More leading players are likely to assign ESG-specific investment mandates to external investment managers, but they probably won’t yet integrate such standards across their entire investment portfolio strategies.
A broader understanding of, and adherence to, ESG concepts is likely to take several years. And it’s unlikely to really gain traction until leading ESG associations, industry bodies, fund managers and regulators can agree on a set of universal standards to measure ESG principles.
“One trouble with ESG is that a definition of what it is varies depending on who you talk to,” said a senior executive at a fund house. “It’s hard to expand ESG in the region until there’s a core methodology that everybody can agree on and which asset owners can understand.”