ESG of minor concern in expanding market

Asset managers are increasingly developing methodologies to select stocks based on environmental, social and corporate governance (ESG) principles, which are believed to have a material impact on the business’ long-term performance.

In Asia, this process is still at a very early stage. However, recent studies and fund launches in the area indicate that the pace of change in ESG, coupled with growing availability of data and increased firms’ reporting, is making it possible to identify companies with high standard of sustainability in the region.

According to research carried out by Vontobel Asset Management in Switzerland, this process will drive additional cash flows to the continent, especially from foreign investors who limit their exposure to the region because of sustainability risks. These include 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 and limited regulation.

In Asia it is often strong-handed governments which are taking decisive action towards more sustainable models, in contrast to the West where it is civil society that is driving forward the process. The difference between leaders in Asia, which are 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.

Picking the stocks that are best positioned, most active and transparent in the sustainability space would guarantee greater performance. Funds that do not invest in a sustainable way potentially have a much higher exposure to risks, according to the study.

But this concept does not seem to resonate with private banks or asset managers in Asia yet.

“Sustainability is an interesting theme,” says Ivan Leung, chief investment strategist at JP Morgan Private Bank in Hong, “but in Asia it is still a bit too new for investors to accept and understand, especially after the recent crisis. Clients are just beginning to accept mutual funds and hedge funds again and this concept would over complicate things.”

Wilfred Sit, head of investment strategy at Mirae Asset Global Investments, explains that corporate governance has been improving in the past decade purely because more and more companies are investing in the region, with large scale IPOs in China in particular increasing the overall market cap of Asia. “The international investor community will put companies under microscopic scrutiny, and that will push for better corporate governance and transparency,” he says.

However, in Asia this is not yet the key driver of a company’s success. “In Europe the market is already saturated, a lot of the companies have a global brand name already, so they need to compete at different levels,” he says.

“But in Asia, the whole pie is growing, especially markets such as China, India, and Indonesia which are just opening up to the domestic consumption potential. Right now the company success comes from being able to build up a global brand name and grow out of Asia.”

There are plenty of globally competitive companies in Asia, whose stocks are capable of sheltering their business through the swings of the business cycle and become long-term winners, he says. These include some consumer electronic companies such as Samsung or LG electronics which have become very strong brands. Also, Asian firms are taking advantage of the difficulties that some Western companies have faced during the financial crisis to gain market share.

“Some of these firms may become more dependent on the global cycle, but they are still emerging companies, they are still growing at rapid rate, they may have to expand into Western markets but the highest demand may still come from China,” says Mr Sit.

In general, the investment focus is on domestic sectors, such as consumer discretionary and consumer staples, which are also the most immune to the global shocks, says Mr Sit. “These should be the core investment sectors over the long-term, as they are driven by the domestic consumption boom in emerging markets.”

Wilfred Sit, Mirae Asset Global Investments