Posted inESG

ESG 2.0 offers route to untapped alpha

Investors should apply ESG analysis to identify long-term structural growth opportunities and returns, especially in Asia, according to Matthews Asia.
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Despite what many asset managers might assume, ESG investing does not only serve the purpose of risk analysis and risk management. Instead, since investing in ESG enables fast-growing companies to seize structural growth opportunities, it can be a source of significant alpha.

Even stronger returns are achievable by focusing on fundamentally sound and innovative companies that will drive positive environmental changes over the long term – what Vivek Tanneeru, a portfolio manager at Matthews Asia, calls “ESG 2.0”.

This is notable when accessing “burgeoning opportunities across Asia’s sustainability spectrum”, where an active strategy can be rewarded with attractive risk-adjusted returns.

“Asia has some of the world’s most innovative and profitable sustainability solutions,” said Tanneeru, who manages the firm’s strategies in Asia ESG and Asia small companies. “It is also where the marginal sustainability dollar will likely generate the most attractive return over the long term.”

In particular, Asia has been a pioneer in areas such as climate change, renewable energy, sustainable transportation, affordable housing, affordable healthcare and financial inclusion.

Active and engaged in Asia

Matthews Asia believes an active approach is needed when allocating to this region. It can make more sense compared with passive investing given that the lack of access to data is a stumbling block when creating meaningful exchanged-traded funds.

This strategy leads to a strong bias towards more developed countries such as Japan, Hong Kong and Singapore, where more data is available – rather than to India and China, or even markets such as Vietnam, which can potentially offer less tapped sources of alpha.

At the same time, the importance of investor engagement to add value to companies – and therefore their portfolios – cannot be under-estimated.

“Active managers do a much better job of actually documenting and showcasing the outcomes and impacts of ESG investment through active engagement and reporting,” added Tanneeru.

Investment trends suggest support for active strategies globally. Data from Morningstar for the first quarter of 2021, for example, saw record inflows of $185.3bn into sustainable funds, 17% higher than the previous quarter. The share for Asia ex-Japan was $7.8bn.

Gearing up for growth in small caps

Amid this appetite and approach is the desire among investors to seek alpha opportunities in small caps as Asia emerges from Covid-19.

“The pandemic has caused serious disruptions to some businesses, including micro lenders or small enterprise lenders as they deploy a very high-touch, face-to-face business model in accessing credit worthiness of borrowers and site inspections or group meetings. Such disruptions to business models create great opportunities,” Tanneeru explained.

The focus on this potential is likely to sharpen further as countries continue to emphasise the transition to more sustainable energy and transportation systems.

As a result, renewable energy and hydrogen are emerging as key growth areas.

“Smaller and mid-caps offer exciting opportunities,” added Tanneeru, “especially in emerging markets as they can lead to strong momentum in terms of stock returns over the long run.”

Part of the Mark Allen Group.