Deep dive into the Environmental, Social and Governance (ESG) opportunities in China

Deep dive into the Environmental, Social and Governance (ESG) opportunities in China

Key takeaways:

  • Chinese regulators are requiring mandatory ESG disclosures from companies.
  • Consumers are becoming more socially conscious and may avoid products from unethical companies.
  • ESG characteristics have a possible linkage to a company’s financial performance.
  • Integrating ESG into the investment process makes a difference to long-term performances.

China’s appetite for responsible investments is on the rise as Environmental, Social and Governance (ESG) investing becomes a mainstream global phenomenon. We take a closer look at how to find ESG investment opportunities in China.

The growing phenomenon of ESG investing in China

Government regulations in recent years have been requiring companies to adhere to social and environmental standards. China has pledged to reach net carbon neutrality by 2060 and regulators are requiring mandatory ESG disclosures for listed companies by the end of 2021.1

Society in general is also much more conscious about ESG issues. Investors realize that analyzing the ESG performance of a company can help them make better investment decisions, avoid risky companies, and identify potential opportunities. We observe that ESG issues could affect company revenues and earnings. Consumers are being more pro-active on social causes and may even abstain from buying products of unethical companies. Companies (not just the health of the public) are bearing the costs of unethical corporate practices. For example, the sales of tobacco companies may be affected by a municipal ban on indoor smoking. The rise in future spending by companies to ensure their products meet ESG guidelines is a factor in our analysis.

Addressing ESG challenges in China

In China, one main challenge is the lack of adequate ESG information on its companies which lag disclosure requirements of Western peers. Some companies may not have dedicated personnel for ESG responsibilities. We often examine the corporate governance of the company, looking at the entity structure (whether private or state-owned), the independence of the board and shareholder composition – these are potential risk areas that could impact the ESG evaluation of a company. When dealing with qualitative data, we do greater research into the management’s future direction, sourcing quantifiable evidence as support and leverage on the expertise of our analysts including our team based in Shanghai.

Asian companies in general are still developing their ESG policies. We take a forward-looking approach when evaluating a company’s current state. For instance, a Chinese investee company may be lagging its Western peers in terms of ESG policies, but it could also be making progress towards its future ESG plans. A company could be practicing fair employment — free of discrimination against gender, race and ethnicity; however, it may not have documented an official written policy on equal employment opportunity. Through our engagement with company management, we often identify areas of improvement and guide management to developing clear and concise ESG policies.

ESG integration and active ownership make a difference

Early results from our analysis show that ESG characteristics may have a possible linkage to a company’s financial performance (see Figure 1), fueling the speed that we are integrating ESG into our investment process. 

Quintiles with better ESG characteristics have been positive in volatile markets 

Figure 1: ESG quintile performance in 2020
Source: Invesco Quantitative Strategies (IQS) Dec 2020 Industry neutral total return, for illustrative purposes only. The ESG scores rank from best [1] ESG score to worst [5] ESG scores into quintile groups covered within the Invesco ESGIntel proprietary research rating system. The total returns for each quintile are the square root of market cap weighted average of members in each quintile using (base=100) for the period 31 Dec 2019 – 31 Dec 2020.

We require an ESG report for each of our portfolio holdings written by the analyst or fund manager who covers that company. While used as a reference, we believe relying on third party research would be too generic and insufficient for evaluating companies. In-depth research is required especially when evaluating the company’s future plans. Through our conversations with company management, board and independent directors, we gain a better understanding of their ESG outlook — these insights are often not reflected in third party research. We believe our analysts with their extensive research experience may be able to evaluate qualitative factors more accurately or identify specific company issues that may have been missed by external resources.

Active ownership involves engaging with the companies to understand their ESG policy direction and empowering change to company. Throughout the year, as active owners of investee companies, we had in-depth ESG engagement calls with corporates, advising on disclosures, reviewing and guiding on ESG issues. In a collaborative engagement, we worked with a group of investors to communicate and monitor the progress of an Asian petrochemical company to reduce greenhouse gas emissions. We believe in taking an active role in driving initiatives forward as a member of the Asia Investor Group on Climate Change (AIGCC).

Why ESG matters to investors

Whether one is an investor, corporate or individual, ESG has implications on the future. From a social and environmental point of view, we are continuously seeking accountability, asking if those companies are making efforts towards their ESG commitments because if they are not — that will hurt their businesses and eventually the long-term performance of investment portfolios. ESG matters, bringing value to our society and making a meaningful difference in our everyday investment decisions.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.

Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.

^1 World Economic Forum. A green wave of ESG is poised to break over China. (4 December 2020)

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