Choking smog highlights ethical investment

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.”