Caixin
Aug 27, 2021 09:02 PM
FINANCE

Having a Social Conscience Can Earn a Healthy Return in China, MSCI Indexes Show

Photo: VCG
Photo: VCG

Investors around the world, including China, are putting more emphasis on how companies deal with environmental, social and governance (ESG) issues, as climate change, business sustainability and good corporate conduct move to the top of many governments’ political and financial agendas.

More China-based fund managers are launching ESG exchange-traded funds (ETFs) and investment products for their customers. A survey of 146 China-based institutional investors, financial advisers and fund managers released in June by American private investment bank Brown Brothers Harriman & Co. (BBH) showed ESG was the third most-popular type of thematic ETF on the Chinese mainland, behind only internet/technology and robotics/artificial intelligence. The survey also showed that 92% plan to allocate more capital to ESG strategies this year.

ESG investing is already paying off. Data from MSCI Inc., a global provider of equity, fixed-income, and stock market indexes, show that its three China ESG indexes have outperformed its benchmark China indexes over three-year and five-year periods to July 30.

The MSCI China ESG Leaders Index, which tracks 173 large- and mid-cap Chinese companies with high ESG ratings as calculated through MSCI’s internal selection process, has recorded an annual average return of 13.4% since 2012, outperforming the 8% annual average return of the MSCI China Index, which tracks 730 large- and mid-cap companies. The ESG index’s three-year and five-year annual rates of return are 9.5% and 14.7% respectively, compared with returns on the benchmark index of 5.8% and 12.6%, figures provided by MSCI show.

The constituent companies of the ESG index are chosen based on a ratings system that measures their resilience to long-term, industry-material ESG risks and how well they manage the risks relative to their peers. The ratings range from leader (AAA, AA), average (A, BBB, BB) to laggard (B, CCC). Alibaba Group Holding Ltd. and Tencent Holdings Ltd. have the biggest weightings, at more than 20% each, followed by Meituan, China Construction Bank Corp., Nio Inc., Ping An Insurance (Group) Co. of China Ltd., and Wuxi Biologics Cayman Inc.

Although China’s technology companies have seen their shares slump over the past few months, that’s due to investors’ perception of higher risks related to areas of data security, privacy protection and regulatory compliance rather than concerns over ESG, Miranda Carr, head of thematic ESG research for Asia-Pacific at MSCI, told Caixin on Wednesday.

The outperformance of MSCI’s China ESG indexes is higher than that for the rest of Asia. The total return from 2014 to July 2021 for the MSCI Asia Pacific Ex Japan ESG Leaders Index was 10.6%, compared with 8% for the benchmark index, and the total 2012-July 2021 return of the MSCI Japan ESG Leaders Index was 9.8%, only marginally higher than the 9.5% rate of the benchmark.

The gap for Japan is smaller because the country has a longer history of practicing ESG, and more companies followed ESG requirements, according to Carr.

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Carr said the number of companies with a good ESG performance are still in the minority in China, which has limited the number of constituent stocks in the China ESG index, so although the gauge may perform better, it also carries higher risks.

The Sharpe ratio, the most widely used risk-to-return measure that shows how much excess return investors receive for the extra volatility they face for holding a riskier asset, was 0.46 for the MSCI China ESG index in the three years to July 2021, 43.8% higher than the ratio for the benchmark index.

China’s regulators are still working on ESG guidelines, standards and reporting requirements for companies to help the government, companies and investors compare them on a like-for-like basis.

“As regulators introduce new reporting requirements for the industry and attempt to create industry standards, we expect that to be a tailwind for further investor adoption of these strategies,” Chris Pigott, a senior vice president at BBH, told Caixin in June.

In an article published in July, Carr wrote that although Asia-Pacific markets traditionally had lower ESG ratings due to low adoption and awareness, as well as limited regulation and reporting, some high-polluting sectors, such as utilities in China, have witnessed improvements in the past three years.

As more capital flows into regions and companies with improving ESG ratings, less will be allocated to Chinese companies listed in the U.S., including traditional internet companies in consumer and media sectors, said Wang Xiaoshu, head of MSCI ESG Research Asia-Pacific.

Contact reporter Zhang Yukun (yukunzhang@caixin.com) and editor Nerys Avery (nerysavery@caixin.com)

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