Improving ESG fundamentals emerge in China

Capturing the momentum of change in ESG performance unveils alpha opportunities in China

2020 M06 4

17 minutes

Capturing the momentum of change in ESG performance unveils alpha opportunities in China

The fast view

  • As China opens up its financial markets and gains wider representation in global indices, we are seeing an improvement in ESG standards and disclosure, albeit from a very low base in the A-share market
  • State-owned enterprises (SOEs) lead the way – many have dual listings, encouraging them to adopt international standards on ESG disclosure
  • There are three key drivers of change: greater representation of Chinese equities in global indices, regulatory pressure and active managers exerting influence
  • There is still a wide variance in ESG performance, so we believe taking an active investment approach is important to appropriately assess investment opportunities
  • The proprietary red and green flags that our 4Factor team use help us eliminate potential risk and highlight potential opportunities to explore further
  • Momentum of change is an important indicator for potential alpha opportunities. This could be captured by engaging with companies and uncovering those companies actively improving their ESG practices

China’s equity market represents a diverse set of opportunities, with varying standards and levels of disclosure on environmental, social and governance (ESG) issues. Along with greater inclusion into world indices, companies are improving their ESG practices and transparency. Such trends could be given extra impetus by the coronavirus pandemic. What has become clear in the aftermath of the pandemic is that investors are likely to demand more socially responsible corporate practices.

Reputations are easy to damage, as food delivery giant Meituan Dianping recently found out. The company’s social criteria came under scrutiny after it reportedly continued to charge restaurants high commissions and insisted on exclusive delivery rights while its suppliers faced a shrinking revenue base. We believe that companies that navigate their ESG path responsibly are more likely to be rewarded by investors, and those that flout ESG practices could be punished.

Looking across the Chinese equity market, A-share companies – stocks that trade in mainland China on domestic exchanges – are lagging their peers, but the direction towards improvement is clear. Capturing this momentum of change offers alpha opportunities. Whether it takes the form of improved operational efficiency, market share gains from better practices and a higher reputation among investors and customers, or better energy usage, all can be positive drivers of shareholder returns.

 

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Specific risks: Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.

All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results.

Authored By

Greg Kuhnert

Co-Head of 4Factor

Joanna Yang

Portfolio Manager

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