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China sees passive ESG fund growth

Although Europe and the US dominate the passive sustainable fund sector, new products have gained traction in China.

Assets in passive sustainable funds domiciled outside of Europe and the US amounted to $10.5bn, representing just 4.2% of global assets, as at 30 June 2020.

But, the growth in the past three years has been driven mainly by net inflows into new product launches, especially in China, according to a Morningstar’s “Passive Sustainable Funds: The Global Landscape 2020” report, published on Thursday.

“In Asia, the speed and enthusiasm with which investors have embraced sustainable investing has varied, and this is reflected in the low uptake of passively managed sustainable funds,” said Jackie Choy, Morningstar’s director of ETF research, Asia.

“Nevertheless, China is now the largest market in passively managed sustainable funds outside of the US and Europe, followed by Australia and Taiwan,” he added.

Passive sustainable fund by market (AUM), excluding Europe and US

Morningstar defines passive sustainable funds as equity and bond index funds and ETFs that use ESG criteria as a key part of their selection process, indicate that they pursue a sustainability-related theme or seek a measurable positive impact alongside financial return.

There were 534 index-tracking sustainable funds that fit its definition, as of 30 June 2020 with
collective AUM of $250bn worldwide. Global AUM have more than doubled over the trailing three years, and Europe remains the largest market for sustainable passive funds, accounting for around three-quarters of global assets.

“As the menu of passive sustainable funds has grown in size and complexity, so has the due diligence burden for investors. Key considerations include a fund’s sustainability focus, approach (exclusions-only, broad ESG, or thematic), sector and geographic biases, tracking error, and fees,” said Choy.

All 20 passive sustainable funds in China invest in the country’s A-shares market, with AUM amounting to $4.1bn. Sixteen of the funds target an environmental theme, and six of these target China A-shares stocks involved in the new energy vehicles industry.

The ChinaAMC CSI New Energy Car Industry ETF which listed in March 2020, quickly gathered assets and became the largest sustainable passive fund outside of the US and Europe by the end of June 2020. With AUM of $1.4bn, the fund is among the largest 10% of sustainable passive funds globally.

In fact, China is also leading the growth of the wider ETF industry in Asia, with AUM increasing 14.7% to $93.6bn during the first five months this year, according to a report by Boston-based research firm Cerulli Associates.

In contrast, Taiwan, which led ETF AUM growth in the region last year with assets rising 130.6% to $55.7bn in 2019 fueled by demand from insurance companies, saw its assets fall to $54.5bn in May, noted Cerulli.

Meanwhile, Taiwan has only three passively managed sustainable funds, two of which were launched last year. Despite the limited options, total AUM of these products amounted to $1.2bn at the end of June, making it the third largest market outside of Europe and the US, after Australia and China.

All three products were ETFs, including one tracking China green bonds: the Shin Kong China 10-Year Treasury Bond and Policy Financial Bond Green-bond-enhanced ETF has AUM of $757 million, making it the third largest sustainable passive fund outside of Europe and the US.

Passive sustainable fund by market (number of funds), excluding Europe and US

Nevertheless, Asia remains a sustainable investing straggler.

Countries in the region accounted for only 2.4% of global inflows into all types of ESG funds, and recorded net outflows of $894m during the second quarter this year, according to another Morningstar report, published in August. The region bucked the global trend, which saw inflows of $71.1bn, up 72% compared with the first three months of the year.

Morningstar acknowledged that the regional figures probably underestimate the ESG fund flows in Hong Kong and Singapore. The two hubs have only $283m and $6m respectively of locally-domiciled sustainable funds, but it is common for Hong Kong and Singapore investors to buy European Ucits funds – including those with ESG mandates.

Yet, a survey of licensed asset managers by Hong Kong’s Securities and Futures Commission in December 2019 found that only 35% of 660 firms consistently integrated ESG factors in their investment and risk management processes.

Other reports 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.

Part of the Mark Allen Group.