Asia expanding in a sustainable direction

The remarkable pace of change in environmental, social, and corporate governance (ESG) in Asia, coupled with growing availability of data and firms’ increased reporting requirements will drive additional cash inflows in emerging Asia, according to a recent report published by Vontobel Asset Management “Investors realise that Asia is a fantastic investment opportunity but many hold assets back because they see strong sustainability risks,” says Falko Paetzold, senior sustainability analyst at the firm and author of the study. These risks include high incidence of air and water pollution, low work standards, child labour, product safety and food security issues. On the governance side, challenges arise from concentrated shareholder structures as well as limited regulation. “What investors don’t know is that thanks to the progress achieved in data availability for identifying companies with high standards of sustainability, it is possible to limit that risk and to actually profit from related investment opportunities,” he adds. By contrast to the West where civil society is demanding and driving forward a process of sustainable development, in Asia it is the often strong-handed governments themselves who are taking decisive action towards more sustainable models. But the difference between leaders, progressive companies with comprehensive sustainability initiatives, and the laggards, whose actions in the sustainability space are more of a defensive nature, is much greater than in Europe, and so are the associated risks and opportunities. “We aim at picking the companies that are best positioned, most active and transparent in the sustainability space. The business case for sustainability funds in Asia is enormous. Funds that do not invest in a sustainable way, potentially have a much higher exposure to risks,” says Mr Paetzold. The thematic sustainable Asia ex-Japan fund, which is part of the Vontobel Luxembourg-based global responsibility product line launched at the end of 2008, has a similar sector and geographical allocation to its MSCI Asia ex Japan benchmark. But under-weights are applied to those sectors that are notably difficult in terms of sustainability performance such as oil and gas, metals and mining, while sectors such as banks or IT are overweight. The fund draws from an investment universe of around 300 companies. Vontobel anticipates strong growth in the volumes of sustainable investments in Asia ex Japan by 2015. The current $20bn (€14.6bn) in sustainable investments, which have increased from $50m in 2002, represents just 0.4 per cent of the global sustainable assets under management. An increase up to the current global average share of sustainable investments alone would mean such assets rising to $1,500bn in the region and could increase to $4,000bn by 2015 if they grew at global rates. “One important topic to consider is that ESG data will become mainstream, and sustainability factors will increasingly be priced into equity valuations,” says Mr Paetzold. Mike Hanbury-Williams, head of Pacific assets at F&C sees that Asian companies are definitely progressing and moving in the right direction, in terms of acknowledging the importance of sustainability issues. However he questions whether the fund industry is at the stage where he can run a general product solely with that type of sustainable investments. Challenges may vary and they may involve convincing a belligerent owner of a company to run his business using a more sustainable shareholder structure. Often companies that do not treat shareholders well have the same valuation multiples as those who do and some companies may not even realise that those are the kind of questions people ask, he says. However, good quality of management will continue to be built into the assessment of a company, and if there is a situation which will physically impact on the underlying performance of the firm, they will actively vote to encourage the right moves; a refusal to do so will result in a decision not to invest, says Mr Hanbury-Williams. Global sustainable funds increasingly have a large exposure to so called developing countries. Natixis Asset Management has recently launched a global equity, thematic sustainable fund, the Global Impact Climate Change fund, which aims at having at least 25 per cent exposure to emerging markets, investing in companies listed in Brazil, Russia, India and China, (Bric), Eastern Europe as well as peripheral countries to the Bric, explains Carlos Joly, chairman of the climate change scientific committee at Natixis Asset Management. “It is a myth that emerging markets are much more volatile and risky than developed countries. The world has changed.” Although sustainability risks are still remarkable, both in developed markets and emerging markets, in the latter challenges relate to the difficulties of finding sufficiently attractive companies, both from a financial and sustainability point of view. Companies known to operate in a sustainable way are mainly multi-nationals, large caps. Also, while most firms do not operate in a sustainable way, there are many which may do, but are not reporting. “The next hurdle in sustainable development investing is to be able to gather sufficiently robust information which will enable us to compare companies. The responsible investing community is not there yet,” he says. In contrast with the best in class approach, according to which funds include the best companies in terms of ESG in all sectors, the climate change strategy allows investment decisions that are not exclusively based on the criteria of sustainable development, thus overcoming the hurdle of a lack of relevant information. The fund focuses on a selection of 39 sub-sectors globally, which are believed to be the most impacted by climate change. “In China we can choose to invest in a rail company or a company that makes electric batteries without really having to do the analysis of best in class, because we know that trains are inherently good in terms of reduction of green house gases,” says Mr Joly. Companies in those sectors will outperform, because their products are, or will be, more in demand because of the impact of climate change. However stocks will also have to pass the classical financial analysis to be included in the model portfolio. “The combination of both factors gives us the conviction that the stocks that we pick in the portfolio with be performing much better than the market as a whole over the long-term,” he says. “I think if we want to sell equity funds again after the crisis, we need these sorts of stories. With this product, we want to incorporate climate change in our global equity investment strategy,” says Philippe Zaouati, head of business development at Natixis Asset Management, explaining that the fund has gathered more than €100m in the French institutional market in two months and retail investors could benefit from it too. Unlike other funds in this space in Europe, which are monothematic, this global equity fund can constitute a core allocation in investors’ portfolios. This is the first of a Luxembourg-based series of funds that the French firm plans to launch in this space. These are going to populate its newly opened Sicav, Impact Funds, which the firm wants to make its flagship product offering in responsible investment.

Growth and performance correlation not clear cut The formidable growth story of emerging markets, and the Brics (Brazil, Russia, India, China) in particular, has provided the main argument for investing in developing countries. And indeed while the past ten years have been a lost decade for equity investors, with the MSCI world index giving a return close to zero, emerging markets have produced an annualised return of 10 per cent. With the staggering equity recovery since March 2009, the belief that future growth means higher returns gained momentum. But findings from the Credit Suisse global investment returns yearbook 2010, by professors from the London Business School (LBS), concluded that there is no evidence that investing in countries that are achieving strong economic growth will lead to higher investment returns. Future returns from emerging markets will outstrip those generated by developed world equities by around 1.5 percentage points per year, but this is compensation for higher risk – as emerging markets are a geared play on developed markets – and are not a reflection of expected economic growth. The study found that the correlation between real growth in GDP per capita and stock market performance was actually slightly negative. This is mainly because economic growth expectations will already be factored into market prices and investors tend to overpay for growth. Historically a strategy of investing in countries that have achieved higher economic growth has underperformed one of investing in countries where growth has been lower. This may akin to the value effect within stock markets, whereby, historically value stocks have outperformed growth stocks. “A value approach of investing in markets that lag behind tends, in a weak way, to outperform,” says Elroy Dimson, professor of finance at the LBS and one of the authors of the study. Although emerging markets are still riskier than developed markets, the gap is narrower; diversification benefits offered by emerging markets have diminished over time but they remain important, according to the study. “Emerging markets have now become mainstream and will, and should, play an increasingly important role in investors’ portfolios, but investors should not write off the prospects for developed markets,” says Prof Dimson.