Whether it is choking smog in New Delhi and Beijing, worker suicides at Foxconn or management failures at Tepco, which ran Japan’s Fukushima nuclear plant, there is plenty of evidence that environmental, social and governance issues have a significant impact on returns for investors in Asia.
Asia has experienced tremendous economic growth over the past decade. This growth has brought huge economic benefits, enabling millions of people to get out of poverty, says Loic Dujardin, director of research products in Asia at Sustainalytics, a research firm.
However, he adds: “It has also created an unprecedented set of environmental, social and governance-related issues that are particularly acute in Asia, such as water scarcity and corruption, to name just a few.”
Yet few investors appear to be taking note. According to James Gifford, executive director of the UN Principles for Responsible Investment, “in the Asian region, we have 73 signatories (10 asset owners, 42 investment managers, 21 service providers), which amounts to 4 per cent, 6 per cent and 11 per cent of signatories respectively”.
So, given the obvious issues that exist, why are more investors not focusing on ESG issues in Asia? “Markets are much younger in their development and investors are simply prioritising what they see as economic fundamentals,” says David Seex, head of Asia Pacific at Adveq, a fund of funds manager, which does embed ESG into its investment strategies.
Even Japan is lagging behind other developed markets, says Arisa Kishigami, ESG executive at FTSE, partly because for so long its market was very domestically focused. There was little pressure from within Japan for change, while “there has been absolute silence from the public pension funds in terms of incentivising fund managers to look at ESG”.
ESG factors are becoming increasingly important in Asia primarily because companies are slowly recognising that this is about sound risk management, says Jessica Robinson, chief executive of the Association for Sustainable and Responsible Investment in Asia.
However, one of the main drivers is that the region is attracting western capital and with that comes western-style ESG. At the same time, stock exchanges in the region increasingly require listed companies to disclose their ESG practices to meet growing interest from investors, adds Helga Birgden, Asia Pacific head of responsible investment at Mercer, the consultancy.
Governance-related issues can be especially important when investing in Asia, says Matthew Vaight, manager of the M&G Asian fund.
“In certain markets the protection of minority shareholder interests can be a secondary priority. However, it is fair to say that at an aggregate level, standards are improving and as the investor base becomes increasingly international, and institutional, it can only help improve governance standards.”
Paul Udall, manager of the GAM Star Geo fund, highlights “a growing number of scandals involving poor corporate governance”, such as the case of Sino-Forest Corporation, which was first flagged up by Muddy Waters, the short seller, and cost John Paulson’s hedge funds an estimated $650m.
He adds: “China, in particular, is in serious crisis in terms of pollution, water scarcity and energy supply. The Chinese government has put the environment at the top of its agenda and is rapidly deploying new policy measures to tackle these issues.”
Other governments in Asia are also strengthening their regulatory mechanisms and enforcement capacity, particularly on environmental and social matters, narrowing the regulatory gap with developed markets.
However, investors need to be wary of seeking one-size-fits-all solutions, as different ESG issues are most important in each market, reflecting very diverse natural resources, cultural aspects and states of development.
“For example, water scarcity and water pollution are immense and often interlinked challenges in India and China,” says Mr Dujardin. “However, in China, water pollution is the biggest problem, while in India water scarcity is most pressing.”
For some investors, the lower standards in the region create opportunities. “We are happy to invest in companies that do not yet reach the highest standards, if we can reach an agreement that management will work to reach or exceed them in future,” says Paul Fletcher, senior partner at Actis, a private equity fund that invests across emerging markets.
He cites the example of Paras, an Indian pharmaceuticals business that the firm sold to Reckitt Benckiser. “It was a family-owned business, but we put world-class governance in place and that allowed Reckitt Benckiser to plug the business straight into its global network. We know they paid a full price. We got a better price for the company because we raised standards.”
The business case for integrating ESG issues into analysis of risk, quality of management and the future prospects of companies’ financial performance is getting consistently stronger, says Mr Gifford. “As it becomes clearer that responsible investment is actually about delivering better returns through more robust risk management and stewardship, we would expect more Asian investors to come on board.”
