The Next Big Thing - ESG and index rebalancing opportunities in Asia
27 Jun 2019 | Michael Marray
As access to the Chinese and Indian stock and bond markets becomes easier for foreign investors, asset managers are facing the challenge of rebalancing their portfolios just as Environmental, Social and Governance (ESG) criteria are gaining in importance. At a roundtable discussion in London, organized by The Asset Events in association with Deutsche Bank, a panel of experts explain how they are facing up to the changing investment environment.
The process of making market access easier for foreign investors is moving along at a brisk pace in both China and India, bringing with it a rebalancing of portfolios. Over the course of 2019, major global equity indices such as the FTSE Global Equity Index Series, S&S Dow Jones Global Benchmark Indices and MSCI Indexes are all making significant changes with regard to China A shares. In April, RMB denominated government and policy bonds were added to the Bloomberg-Barclays Global Aggregate Bond Index. And in India, the Foreign Portfolio Investor (FPI) rules are going through a series of adjustments.
Anand Rengarajan, head of securities services, Asia Pacific, at Deutsche Bank, expects to see a gradual surge of investment into the Chinese onshore bond market, in the wake of inclusion in the Bloomberg Barclays Global Aggregate Index from April 1.
“Timing is clearly one of the factors in making an investment attractive, and the US-China trade war may have made some investors hesitant, but in the medium to long term investment flows will increase,” Rengarajan says. Similarly, with regard to A shares, investors need to understand the entry process, and get ready for changes in stock indices and the impact on stock allocations.
In India, Prime Minister Narendra Modi wants to continue with financial sector reforms, and investment flows into India are likely to increase following his recent landslide re-election.
These portfolio adjustments in response to index rebalancings can pose a challenge for asset managers, as they are under pressure to increase their allocations, while at the same time seeking to follow their own house view on market outlook.
“Each individual client will have their own assessment of benchmarking and opportunities,” comments Neil Dwane, global strategist at Allianz Global Investors. “The Chinese bond market is the third-largest in the world, and even if you don’t buy now you have to think about the long-term consequences as the market opens up.”
Similarly, global investors will gradually move up towards a 20% allocation to Chinese listed stocks. “The regulatory, tax and FX framework is evolving, and those changes are the bigger story, and the context in which we are talking to our clients,” says Dwane.
This rebalancing in favour of China, India and other emerging markets assets comes at a time of great change in the asset management industry, which is also adjusting to pressure from investors for ESG considerations to play a more prominent role in stock and bond selection. This presents both a challenge and an opportunity for asset managers as they compete for mandates.
“Amundi has made an important mission statement setting out its ESG ambitions, and now we have to work out what that means for many different portfolios,” says Andrea Salvatori, head of emerging markets ESG at Amundi Asset Management.
“All across the industry there is an opportunity to define E, S and G, and each firm will have different criteria. There will need to be nuances according to the client, but each asset manager will define its own take on ESG and develop a distinctive brand,” he explains.
Simply allocating according to an index such as the S&P 500 will not meet environmental targets. But green investing will mean different things to different investors. One obvious example is the Middle East, where investors are showing an increased interest in ESG, but given the region’s heavy reliance on oil revenues are unlikely to consider excluding oil related stocks and bonds from their portfolios. Some investors may want to place more emphasis on social issues rather than environmental (eliminating child labour from global supply chains would be one example).
“ESG represents an opportunity for asset managers to differentiate themselves,” comments Tom Wildgoose, head of equity investment at Nomura Asset Management UK.
ESG considerations are now coming into focus in addition to performance, and firms will need to state their philosophy on responsible investment, Wildgoose says. “At Nomura Asset Management we have set out our ESG values,” says Wildgoose. “Investors can look at what they believe in - and find the right asset manager to reflect that. An asset manager has to have lines that it will not cross, for example on the uninvestibility of a stock, or saying no to a client at some point - to say your brand does not match our brand.”
Need for reliable data
There is a clear trend among investors around the world to consider ESG factors, including in Asia, which has lagged Europe in this area. Japan’s Government Pension Investment Fund (GPIF), the world’s biggest pension fund, now requires all its asset managers to integrate ESG into their investment analysis and decision-making, and many Japanese institutional investors are expected to follow its lead.
As Archie Beeching, Director of Responsible Investment at Muzinich & Co, points out, there is a vast amount of wealth being handed down to the younger generations, and millennials in particular are concentrating more on ESG factors.
“Many externalities are currently not priced in, and investors need to address these externalities,” he says. “ESG factors are integrated into credit research, with the aim of improving risk adjusted returns over time.”
Salvatori from Amundi also sees a generational change impacting the industry. “By showing that you have a distinctive ESG methodology embedded into the structure of portfolios, and being transparent about principles and showing the methodology, asset managers can shape the relationship with the owners of their funds - and this is in particular the case with Gen Y and Gen Z investors,” he says.
But to do all this, large quantities of reliable data are needed. However, the patchy quality of data remains a problem all over the world, and not just in emerging markets.
There are attempts to improve this situation. Beeching points to the work of the Network for Greening the Financial System, which recently published a set of recommendations that included bridging the data gaps and supporting the development of a taxonomy of economic activities. the European Commission is about to release a taxonomy of sustainable economic activities and an EU green bond standard. “Corporates need to be more transparent, and investment labelling needs to be more regulated,” he says.
“We all need help to see how to allocate capital differently, but the available data is of poor quality, and many of the Mid-Cap listed companies around the world don’t know what data to provide - or perhaps do not even know that they are being evaluated on ESG,” adds Dwane at Allianz.
“It takes time to engage with companies, and at meetings there is only a certain amount of time that you can carve out to discuss ESG,” says Dwane. The best approach is to pick specific topics and stick with them once a company is engaged. One high-profile governance issue at the moment is cyber-security, and the risk to a brand if their customers encounter problems online.
Wildgoose at Nomura also sees engaging with company management as an area where active asset managers can differentiate themselves from passive funds, and justify their fees.
“We bring our own perspective, and engage with companies on issues where they can improve,” he says. In the governance area, management reward structures are currently a prominent theme.
In an era of loose monetary policy, many companies have taken on cheap debt, while boosting their earnings per share via stock buybacks.
This has led to big stock option payouts for top management. Investors are keen to promote remuneration packages that reflect real value creation, rather than just the impact of stock buyback programmes.
Rengarajan at Deutsche sees ESG factors as growing in influence, including in Asia. He notes that regulators in Asia have generally not gone too far in terms of policy, but that this is changing.
For example, the Hong Kong Monetary Authority has incorporated ESG principles into the investment processes of its Exchange Fund, while green finance is actively being discussed in China, Singapore and India.
That is probably an indication of things to come, and more investors will be looking at ESG as they rebalance their global stock and bond portfolios.
“There are a lot of changes happening in both China and India, giving better access to foreign investors,” says Rengarajan.
“For example, India has opened up commodities trading, while China is talking about opening up bond and equity futures markets. So investors need to be prepared for more changes to come.”
Treasury Review 2020