“A values-aligned approach provides clients with strong investment opportunities, diversification, and protection from risks related to key issue areas such as regulation, climate change, and employee treatment,” according to Julie Koo, Asia Pacific head of managed investments, Citi Private Bank.
“Private bank clients are also increasingly expressing a desire to align their portfolios with their personal values, such as concern for the environment and for society at large,” she told FSA.
Yet, Asia is still an ESG laggard. Several surveys show that the main barriers to ESG integration into fund managers’ investment processes are a limited understanding of ESG issues and a lack of comparable, quality data.
A survey of licensed asset managers by Hong Kong’s Securities and Futures Commission (SFC) in December 2019 found that only 35% of 660 firms consistently integrated ESG factors in their investment and risk management processes. Also, a Morningstar report last year noted that ESG investment in Asia significantly lagged other regions, while “greenwashing” or providing misleading ESG claims, was rife.
However, ESG measurement tools are becoming more sophisticated and fund methodologies are increasingly transparent; regulators are playing an important role through “green” initiatives and with more effective monitoring of ESG funds.
Meanwhile, wealth managers share a common belief that ESG factors will continue to grow in importance, but they insist on a rigorous assessment of the ESG claims made by fund managers.
“They must have a comprehensive ESG analysis framework that is integrated tightly into their overall investment process and supported with reporting on their ESG profile and social impact. Furthermore, they must demonstrate an engagement strategy with the companies they own, whether through shareholder activism or proxy voting,” said Koo.
Deutsche Bank Wealth Management examines multiple ESG aspects when selecting fund managers, reviewing their operational set-up and factoring in social and governance aspects as well as environmental ones.
“We look, for example, at what rating the funds they manage get from third-party rating firms, and whether the funds have exposure to potentially harmful industries,” said the bank’s Markus Mueller, global head of its chief investment office, who pointed out that better data availability means that ESG issues can be measured, so that transparency around investment strategies is possible.
Pierre DeGagné, head of funds selection, at DBS Private Bank in Singapore, “seeks to identify broad-based funds with strong teams, heritage, depth of focus on ESG, innovation, and most importantly, sustainable competitive advantages that make them more likely to outperform their given benchmarks”.
“While ESG is not a simple check-list to success it is helpful in making better investment decisions,” said DeGagné.
Pierre DeGagné, DBS Private Bank
Countering distrust
Nevertheless, there is often scepticism about the ESG claims made by funds, especially now that ESG is fashionable and routinely promoted by marketing departments.
For instance, Isaac Poole, chief investment officer at Oreana Financial Services in Hong Kong is “wary of ESG claims and tend not to take these at face value”.
Poole “prefers clear evidence and examples of how ESG is incorporated into a [fund’s] investment process”, adding that “ESG and sustainability can contribute to long-term alpha, so we prefer examples from our managers that show this has clearly and quantitatively contributed to their outperformance.
“When funds talk about ‘ESG processes’, we like to speak to their experts and gauge how they interact with the portfolio management team,” he said.
“Besides, ‘sustainability’ is a more useful lens through which we can consider ESG, and help move away from the recent fad of building out the latest theme-based funds,” he added.
A report last March by the Economist Intelligence Unit (EIU), called “Financing sustainability: Asia-Pacific embraces the ESG challenge”, found that 68% of 161 investors in Australia, New Zealand, Japan, Hong Kong and Singapore intend to increase their allocations to sustainable finance over the next year. In addition, 27% of survey respondents expect to have 25%-50% of their AUM in sustainable investments in three years’ time.
However, the EIU report also found that fundamental market challenges around the supply of suitable securities – not simply the integrity of an investment product’s ESG claims – will hinder the market’s development in the short- to medium-term, as companies struggle to determine the qualifying criteria for green or other sustainable assets.
Regional investors naturally want assurances from issuers that the funds provided are being used for sustainable purpose. Indeed, demonstrable ESG credibility of an asset manager and its promoted funds is all-important to investors.
“We need to know whether ESG one of their key strengths or just a side business for them,” said Arjan de Boer, deputy chief executive, Hong Kong branch of Indosuez Wealth Management.
“We also look at how they incorporate ESG into their asset and sector allocation and security selection, how they perform ESG screening and how they combine financial and ESG analysis,” he added.
Hearts and minds
Among investors, there are also concerns that they might sacrifice performance if they invest with their “hearts rather than their heads”, and prefer to separate investment decisions from their philanthropic activities.
This is perhaps especially the case in Asia, where wealth management clients tend to erect a clear barrier between their philanthropic activities and their investments, according to Adrian Zuercher, Hong Kong-based co-head of asset allocation, UBS Global Wealth Management CIO in Hong Kong.
“However, we now have sufficient data to show that they will not sacrifice returns by opting for an ESG-compliant product,” he said.
For instance, the MSCI AC Asia ex-Japan ESG Leaders index has a three-year cumulative return of 14.16% (to 1 June 2020), three times the return of the MSCI AC Asia ex-Japan index, according to FE Fundinfo data.
“Globally, demand for ESG investments are our fastest growing mandates as clients are aware of their risk management qualities, and increasingly understand that returns are at least as good as conventional funds,” said Zuercher.
In fact, 68% of Asia-Pacific investors surveyed by the EIU said that their sustainable investments performed better than their traditional equivalents, with as much as 80% of Singapore respondents saying they outperformed, and all of them firmly debunked the notion that there is no financial benefit to sustainable investing.
“Although a clear link between high ESG scores and financial outperformance is not yet established in Asia, there are strong signals this is about to change and follow the European and US trend,” said Boer at Indosuez.
Deutsche Bank WM’s Mueller agrees that ESG integration does not necessarily mean compromising on returns and can actually enhance them over a long-term horizon through encouraging investment in higher quality companies with a sustainable business approach.
“In the current market phase, we are seeing ESG strategies outperform the broad market, due to the underweight in ESG portfolios of more controversial sectors, such as fossil fuels,” he added.
Nevertheless, a greater inclusion of ESG criteria among asset owners’ demands and expectations will take time.
“Deeper client education is still required for the ESG industry to really take off, because many wrongly perceive ESG as satellite or alternative investment products, and would therefore allocate only a modest part of their portfolio to ESG funds,” said DBS’s DeGagné.
“There is a need for clients to understand that ESG isn’t a product type, but is an investment selection method which can contribute to generating alpha when properly harnessed,” he said.
