The rise of energy prices and rotation out of growth stocks in Asia have weighed on relative performances of ESG investments, leading to scrutiny on whether investors should continue to consider ESG within their investment portfolios.
Despite coming under market pressure, we continue to see resilience in ESG portfolios. Long-term positive performance of ESG stocks is underpinned by two key drivers – sustainability opportunities aligned to Asia’s growth and strong ESG credentials helping companies protect against business risks.
The caveat however is the quality of ESG integration and being able to evaluate material ESG factors. Not all ESG factors are equal, and the ability to identify the critical environmental, social and governance factors that impact a company’s ability to do business and grow is key.
For example, with many Asian internet companies, there has been an increased focused on data privacy and security. For manufacturing companies, heightened spotlight on employee working conditions and carbon emissions are part of what multinationals are doing to tighten environmental and social requirements for their supply chains.
There are a number of sustainability opportunities to be found in the various industries and sectors in Asia. Asia’s low-carbon transition continues to face strong structural tailwinds as more and more governments step up their net-zero commitments. In fact, almost two-thirds of renewable power built in 2020 is in Asia. The region has also emerged as a key producer of many materials required for the shift to a low carbon economy. For example, the majority of the world’s EV batteries comes from Asia, creating unique investment opportunities.
Beyond climate, there are also growth prospects in meeting the social needs of the emerging affluent and affluent populations. Two sectors that stand to benefit are healthcare and financial services. Growing affluence has led to more focus on promoting healthy lifestyles and well-being, hence increasing the demand for healthcare services. In financial services, there remains a huge structural opportunity in financial inclusion for the un-banked and under-banked.
Finally, when it comes to the “G” of ESG, identifying companies with strong corporate governance remains key. While about 70% of companies in Asia have a controlling shareholder and board independence, this is low compared to Europe. Being able to determine the quality of the management, together with its commitment to improve their corporate governance over time, continues to differentiate top performing companies from their peers.
ESG regulation
Policymakers and regulators in Asia have been stepping up policy interventions in recent years, particularly around climate. For example in Singapore, starting from this year, listed companies in the financial, agriculture and energy industries will be required to provide climate-related disclosure. The requirement will apply to listed entities in the materials and building industry and transportation industry after 2024.
Carbon taxes are also being rolled out or raised in a number of markets in Asia. The increased regulatory focus across markets makes it more costly for companies with poor ESG management to operate. This has in turn driven companies to accelerate their implementation and disclosure of ESG policies to stay compliant and ‘future-proof’ their business operations.
In Asia, investors are in an advantageous position given there is a relatively higher number of firms that have room to improve their ESG profiles and, in turn, their performance – something that will inevitably occur given growing sustainability awareness. Companies with better ESG performance and track records can gain greater access to capital, which will translate to lower cost of financing, leading to better financial performance over time. This also increases the potential of further earnings upgrades for companies, and enhanced returns for investors. Conversely, companies with poor ESG practices will be penalised and potentially excluded from portfolios.
Challenges
That said, ESG investing is not without its challenges. ESG disclosures are still patchy and inconsistent amongst companies, making it difficult for investors to make informed investment decisions based solely on available company information.
While there are a number of taxonomies in place, they are not harmonised and at times not interoperable. The lack of standardisation makes it challenging for investors to make like-for-like comparisons across companies. Whilst there are efforts by regulators to unify the disclosure requirements, it will take some time before it’s fully implemented.
Beyond the equities and corporate bonds space, meaningful ESG data is also still developing for the other asset classes, in particular sovereigns and private assets. This makes it challenging for investors to incorporate ESG considerations consistently into their whole portfolios.
Yet being focused on the material ESG factors and themes that are relevant to Asia will make a difference for investor portfolios. Amid constraints with ESG data, in particular with Asian companies, getting a head start to incorporate some of this non-financial data into one’s investment decisions will benefit investors in the long run.