ESG and Sustainability – Refining the Investment Proposition to Attract Asia’s HNW Clients
Mar 29, 2022
If there is a major investment wave to ride in the world today, it is surely the wave of ESG, impact and sustainability. It originated actually some decades ago in the US and Europe, and in recent years has really gained power and momentum and is now flooding the investment landscape worldwide, and increasingly so in Asia. The Hubbis Digital Dialogue of March 17th analysed the world of ESG and sustainability from the viewpoint of how it impacts the Asian private wealth market to determine what the fund management community, the private banks, the EAMs/IAMs/MFOs and the single-family office are doing to ride the wave, or perhaps to find out why some of them might still be watching from the shore.
- Qiusha Zhan, Associate Director, ESG Specialist, CSOP Asset Management
- Marc Lansonneur, Managing Director, Head of Managed Solutions and Investment Governance, DBS Private Banking
- Stephanie Maier, Global Head of Sustainable and Impact Investment, GAM Investments
- Arjan de Boer, Deputy Chief Executive, Head of MIS, Asia Markets, Investments & Structuring, Asia, Indosuez Wealth Management
- Jean-Louis Nakamura, Chief Investment Officer, Asia Pacific - Chief Executive Officer, Hong Kong, Lombard Odier
- Stephanie Leung, Director & Head of StashAway HK and Group Deputy CIO, StashAway
These are some of the questions the panel addressed:
- What is the Asian WM community doing to adapt their products, services and expertise to the evolution of the ESG investment market today and for the future?
- What are the expectations of investors in relation to ESG, Sustainability and Climate?
- How are you delivering on their expectations?
- What are some of the issues - data quality, reporting, consistent regulations, etc?
- How do you discuss the investment strategy with clients who are interested in ESG and Sustainably?
- How do you frame the conversation with clients?
- What are the consequences of ESG factors when related to portfolio performance and risk?
- When selecting funds – how do you decide what is relevant and appropriate?
- How can Asia’s wealth industry curate the best range of ESG investments, from individual stocks, through funds, ETFs, DPM mandates, and so forth?
- How can ‘The Climate Pledge’ potentially drive ESG investing growth in Asia-Pacific fund industry
- Is there a passive route to ESG?
- Is there a positive impact of the metaverse on carbon emissions?
Setting the Scene
As we know, environmental criteria aim to define how a company performs from an environmental impact perspective. Social criteria define how a company manages relationships with employees, suppliers, customers, and the communities in which it operates. And governance deals with a company’s corporate culture, its leadership, executive and broader compensation, audits, internal controls, and shareholder rights.
But what does it all mean to investors? Well, a growing body of research shows that ESG investors who support these more ‘sustainable’ companies/assets can make a positive difference to the world whilst reducing investment risks and also harvesting more competitive financial returns.
This recognition is spreading, and the growth of ESG in both popularity and coverage is almost certain to continue, especially as the arrival of more data and more ratings and greater confluence of standards will increasingly influence the decisions of fund managers from sovereign wealth funds through the world’s largest pension funds and all the way down to retail investors, especially these days the HNW and UHNW investors.
In short, these ESG criteria are used to help investors identify companies with corporate values that they feel comfortable with and therefore that accordingly meet their investment requirements. The theory goes that investing in single assets or in funds that are aligned with approved or rated Environmental, Social and Governance (ESG) criteria will help private investors align with the major institutional investors who increasingly shun investments that do not appear to do their utmost to improve their E, S and G footprints and qualities.
The mission for our panel of experts on March 17th was less to analyse ESG itself and more to look under the hood of the approach that Asia’s wealth management community is taking to spreading the ESG word across the region. As the world’s leading global investors continue to embrace ESG, what progress is being achieved amongst wealthy investors in Asia, and specifically, are Asia’s private clients jumping increasingly on the ESG express? If they are, why and are they pleased with the outcomes thus far? If not, then why not?
The Discussion, the Key Observations and Insights
Tracking the rising tide of interest in ESG, sustainability and impact amongst Asia’s private clients
“All our clients have access to the information on ESG that we and others provide, and some are very interested, while others are increasingly keen to know more about it all,” a banker told delegates. “We have for some years now been building our private banking infrastructure and offering across the region. A key element of the expansion strategy involves striking a chord with the younger generation of actual and potential clients, tailoring products, services, personnel and delivery methodology to their expectations. As a key part of this, we have been building and conveying its vision of ESG investing.”
He said the message for them all is around integrating ESG criteria within the portfolio, alongside the usual investment criteria, in order to build a portfolio and introduce products as essentially a free insurance against E, S and G risks. “Asian private clients increasingly understand this and see more and more that the portfolio can perform better as a result,” he reported. “When you use the ESG layer on top of the standard financial selection criteria, clients see that they can also do good from a sustainability point of view.”
Helping Asia’s private investors warm to ESG, by bringing the European experience and perspective to bear
A banker opened his commentary by reporting the growing interest in ESG in his core markets of Hong Kong and Mainland China. “And we also have rising interest to see what can be done in China not only in terms of ESG strategies but also incidentally in terms of temperature alignments and low carbon strategies,” he said. “It is clear that environmental issues are increasingly important for political and policy agendas. In short, we will see increasing prominence for ESG and sustainable products and strategies in this part of the world.”
He pointed to a survey his bank had conducted in 2021 among private investors. “We learned yet again how a very significant and increasing proportion of HNWIs are convinced that the inclusion of ESG criteria and sustainability in their investment strategy will lead in the future – and here I mean later and not yet - to better returns and better resilience of the portfolio.”
He said there is more information when you mine down into the findings, differences between countries and also between generations, and between men and women. “But the big picture,” he reiterated, “is the strong and rising interest and focus on this subject and a greater tendency to include these metrics and factors in their investment decisions, already today or sooner rather than later.”
He expanded on the reasons why clients are willing to follow ESG. “There is no single answer,” he explained. “However, some of them firmly believe that the companies in which they put their money should have certain ESG attributes. Others are concerned about reputational matters. But there are impediments, and this centres on the limitations on the data and the transparency and the metrics.”
He explained that their bank had realised this some years back. “We saw that an increasing number of clients were interested in going beyond understanding and assessing business practices, even issues such as potential disruption in supply chains from environmental and geopolitical troubles. So, we moved to enlarge the analysis and to go beyond the traditional ESG approach to what we call a fully integrated sustainability approach. We focus on more than the ESG scoring of the business practices – and we believe our is already quite refined – and developed the analytical framework to understand much more about the business model.”
For example, he reported that a mining company with an advanced approach to decarbonisation could end up with a better overall rating than an Electric Vehicle company with bad social practices. “You have clients who want to have what I can call ‘clean’ companies from a business practice point of view,” he observed. “These investors want to have a portfolio whose trajectory is more in alignment with the Paris Agreement, and to do so; you need different layers of assessment covering business practices, business model, business location, and to understand ultimately which company can survive the kind of world we will be facing in 20, 30, 40 years.”
To be known as a true ESG and sustainability leader means a total commitment from top to bottom throughout any financial organisation
A banker reported that as part of a major European banking and asset management group, they had become known today by the nickname of the ‘Green Bank’, as they have long committed resources and focus to this area, and are today one of the largest, perhaps even the largest originator of green bonds.
“We actually started adding E, S and G scores in our client statements back in 2015, so we're clearly early adopters. And indeed, at the individual security or product level, we report the E, S and G scores, for each security, each fund, each bond, and obviously, also at the portfolio level. So, you have your average scores, your low score, your high score.”
Additionally, he told delegates that they had an internal campaign a few years back, where they devised so-called ESG scorecards that following an internal education drive their investment advisors and bankers could discuss with our clients.
He observed that a lot of clients are waking up, either because after wealth transition, the younger generation is clearly more interested for the purpose of creating a better world, and many of the older investors start to realise that returns are actually better for equities with strong ESG credentials. “We are now working with our major global asset management group and we have our ESG Academy, so, all our staff, frontline staff predominantly, have a regular interaction with their specialists on different topics, so different themes within ESG. We make sure that the teams are continuously being educated and the next step is that we're going to organise this ESG Academy for our clients as well.”
And in terms of products, he added that they have specific funds, different green or blue structured products that are increasingly popular, as well as specific DPM mandates. “One of them is called ‘People and Planet’, for example,” he reported.
He also pointed to some fascinating projects, for example, working on a proposal for a large family office on the private equity side related to one of the large Spanish oil majors investing in a large reforestation project in Spain, with the payout in carbon credits, which subsequently can be traded again for profit. “There are many interesting offshoots, including the green bonds, blue bonds, gender bonds, structured products, green funds, and so forth. This space is fascinating and offers scope for some really interesting communication between financial institutions and clients.”
There is more and more momentum in Asia that is today driven by the local and regional banks, managers and regulators
Another guest pointed to the ESG push in Asia as well, noting that in Hong Kong, global managers have launched sustainability-focused products for accredited investors in recent years, and that regulators and associations are aiming to introduce standardised disclosure, especially in climate and carbon transition. Moreover, the Hong Kong SFC will require fund managers to prepare their climate disclosures by August 2022. And Mainland China's asset management industry is expected to continue to reflect the national economic transition to high-end manufacturers and more sustainable activities and policies.
“In terms of demand for ESG products, the regulatory policies of Asian countries are becoming clearer, especially on the low carbon emission reduction,” they reported. “Moreover, this is catching investor attention, especially for those backing the long-term decarbonisation efforts and related opportunities. Many large insurance companies and pension funds have started to require managers to measure their portfolio carbon emission and set the reduction targets. All in all, there is a very positive outlook for the Asia fund industry in these endeavours. The demand for ESG products or ESG thematic products will certainly increase.”
Digital Platforms are also curating more and more ESG-driven portfolios for their clients
A guest reported that their digital platform client base, one of the largest in the region and made up of 80% retail/mass affluent and 20% HNWIs, was increasingly interested in taking ESG-driven model portfolios, such as one named Responsible Investing. They explained that the risk profile is adjusted to reflect ESG scores. Another recent offering is a thematic portfolio focused on green investment, which delves into areas such as clean energy, clean water, waste management. “These two products face up to an increasing demand from our customer base for ESG related investments,” they explained. “The trend coming from the US and Europe is taking off in this region.”
There are a number of key trends emerging that asset managers around the world are increasingly factoring into their investment strategies
A guest observed how a robust sustainability framework also looks intently at ESG integration. “So, how do we incorporate the relevant environmental, social and governance issues into our investment decision-making?” they pondered. “The answer is it varies across different strategies, and is forward-looking as the emphasis on some of these issues will differ in the future as well. Secondly, there is active stewardship, so as we analyse companies and as we are holding those companies in our strategies, it is about how we engage with them to better understand the risks and opportunities but increasingly, also, how do we drive better outcomes and performance from those companies for our clients.”
They also pointed to the broader issue of the rising prominence and importance of the investment manager community in the transition towards net-zero, really taking a leadership role in helping clients to decarbonise their portfolios and reach some of the other key [sustainability] goals.
“In the wealth management market, there is a lot more focus on and thinking around where private money is going, what that capital is achieving, as well as obviously the vital return elements as well,” this expert commented. “Transparency is really vital, both for our clients and for us. Accordingly, we also provide our clients with external ESG scores, and we also look at a set of different climate scores on the portfolio and illustrations on the company as well. This is an area in which we're seeing a lot more focus as well.”
And finally, the fourth element is obviously the products and the solutions, and here they reported there is great opportunity to deliver for clients. “We have been developing specific solutions, for example, around climate bonds or thematic equities, where we see more and more clients interested in understanding and seeking to both drive and navigate some of those big trends. Obviously, the net zero future is one of those big trends, but so too is sustainable consumption, the transition to a more circular economy, and some of the other challenges beyond climate change, such as biodiversity, and health, both areas that clients are really keen to access.”
The EU’s SFDR, or Sustainable Finance Disclosure Regulation, is having a major impact already
In March 2021, the European Union’s Sustainable Finance Disclosure Regulation (SFDR) came into force. A banker reported that the EU’s relatively new SFDR is forcing asset managers and other financial intermediaries to focus more directly on these issues and their responsibilities. The SFDR is designed to help institutional asset owners and retail clients understand, compare, and monitor the sustainability characteristics of investment funds by standardising sustainability disclosures.
Under the SFDR, firms must make both firm and product-level disclosures about the integration of sustainability risks, the consideration of adverse sustainability impacts, the promotion of environmental or social factors, and sustainable investment objectives.
The SFDR is very important as it imposes mandatory ESG disclosure obligations for asset managers and other financial markets participants, a guest said. SFDR arrived in 2021, and one of the elements that's going to be introduced early next year is these principal adverse impact indicators, which is a set of indicators that start looking at the impact of the companies in the portfolio. And that, for example, includes things like the proportion of women on the board, or perhaps the impact in protected areas on the biodiversity side, as well as the carbon emissions score, and so forth.
ESG scores and sustainability measurements must be carefully curated and set against a variety of views from different providers
Another banker added that on the data coming from the companies themselves, and its relevance and the transparency around that data, as well as the ESG scores that emerge as a result, each provider of those scores has its own methodology and that there is some inconsistency sometimes. “We onboard MSCI scores, but yes, we know nothing is perfect,” he conceded. “However, what is important is to have something to give to the clients and to discuss with clients and to use as a platform for education around these issues. And then there are the carbon indicators, which are actually more reliable, so we can also help in the assessment of companies and the portfolios' carbon footprints.”
ESG data quality and consistency will improve over time, there is increasing focus from the regulators, intermediaries and major investors
Expanding on these themes, an expert observed that data has been and will continue to be a key issue given that increasingly, ESG-driven investment decisions are being made increasingly on that. There are as yet no single standards for ESG, a banker reported, but he expected this will emerge over time. “We actually work not with one but with eight other companies that could help us provide our ESG scores,” he explained. “We layer our own analysis and assessments on top of the work we do with companies like MSCI, Refinitiv, Sustainalytics and others.
Data delivery and analysis are essentially all rules-based, another guest noted. “So, if your data is not right, then the outcomes are not right. We are seeing increasing scrutiny of that data, and we are also using a wealth of external research providers and data points. However, at our firm we also conduct our own extensive and fundamental research, because that enables us to understand some of the limitations of the data that is out there, and also to plug some of those gaps and overlay some of that with a vital qualitative assessment as well.”
She explained that they are seeing regulation help to gradually drive better data. “That might be around mandating climate-related disclosure by companies in Europe, but also gradually in Asia, through listing rules, for example, and a wider drive towards better disclosure on a range of sustainability indicators,” she said. “The other element around regulation that we really need to touch on is within Europe, where we now have the EU taxonomy, and we have other countries developing their own taxonomies. Accordingly, the definition of what is green, and what is the green activity, and of the taxonomy, all these are coming into a sharper and very specific focus from a regulatory perspective. We need to better understand what we all mean.”
Mining down into ESG data and the ongoing evolution of data and regulation, it seems clear that the cream will gradually come to the top
Another guest took this line of discussion further to extrapolate to a world where a greater clarity of the rankings of the true ESG leaders will gradually emerge.
“We are obviously active investors, and while there's definitely a place for the more kind of rules-based products [such as indices and ESG ETFs], they are essentially limited by the criteria and the formula that you write in,” she said. “That means they end up with a lot of big-name tech and financial sector companies as big holdings at the top of those. But take for example, the banks. There is no assessment built into those indices or ETFs on the emissions the banks finance through their lending or other activities, and there is no direct link to those lower carbon companies that are out there.
But she reported an increasing interest in products that can look beyond all those front-line data points and scores to the future and the right opportunities in the years ahead. You are seeing that particularly in the thematic space, where there is more alignment of green revenues and other sustainable development goals, and these areas are not coming through with sufficient importance or quality in the passive products. And that is where the dynamic, actively managed curation of ideas and opportunities scores so well.
She observed that the other challenge around some of those more sort of formula-based approaches is the data is largely backward-looking data. And we are now entering into a world where we think regulation is going to play a much larger role in shaping the market and the winners and losers.
“But for the time being, indices and passive funds have larger-cap companies at the top, because they are larger, and most importantly because they also have the resources for better disclosures, better policy policing and procedures. They also benefit from the fact that they've been the focus for investors engaging on these things for longer. And that is, very oddly, how you end up with very well-ESG-rated extractive companies in there. You would very much hope that anyone engaged in mining has an excellent environmental health and safety management but that is not always the case of course. In short, you really need to understand the criteria in order to understand what you're going to end up with.”
Nowadays, however, she reported that more clients are thinking about what it is they really want to target. “We are moving a bit away from ESG as just a sort of a risk lens, which is definitely still important and more towards how we integrate ESG factors alongside the impact, and then leading through to the opportunities that arise,” she reported. “And that process, that thinking, is we believe in the process of leading us to the curation of a much more varied set of companies and opportunities that are of greater interest to clients.”
Education of the client-facing bankers and advisors is vital for the rollout of ESG-driven investing in Asia
A banker explained that within the private bank, the first step is educating and engaging the RMs and advisors. “You cannot effectively engage with clients on these topics unless you have well-informed proponents within the organisation,” he told delegates. “We train our teams, and we keep training them. Sustainability is actually part of a compulsory bank course that all the relationship managers, investment counsellors, even product staff have to take when they join us, or when they are here. And in terms of governance, we have a group sustainability counsel, which I was honoured to be a member of, and that we also have in each country, meaning in Taiwan, Indonesia, India, Malaysia, Hong Kong, China and obviously Singapore.”
Additionally, he explained that the bank has a task force driving the sustainability agenda across all business units, whether it is a solar panel on the bank in Singapore or in an office in Singapore or in China, or perhaps a private equity product the bank might be proposing in Singapore to clients, and that has valuable sustainability or high impact.
“Training in these issues is ongoing and things change rapidly, and it is complex,” he added. “And when you train your RMs, you see how complex it is to reach your clients, because RMs don't understand or don't get the full picture, or at least understand easily what the communication and the angle we want to develop, for example the full integration of ESG to investments, climate, carbon footprint, offsetting, in portfolios. The better we train them, the better they are able to explain things to clients. Education is therefore a key priority in the drive to ESG and sustainability at the bank.”
Better performance from ESG-driven investing? Yes, says experts, there is a growing body of evidence that it produces better quality, consistent returns and all with lower risk
A banker stated that for a number of years now it had become clear to their group that portfolios that are structured with securities with very high ESG credentials actually perform better. “That will become even more the case ahead as central banks increasingly participate, so 27% of central banks at the moment are taking this into account in their reserves management, up from only 14% only a few years back. Institutional investors worldwide are taking this more and more seriously. So, purely from a supply and demand point of view, you'd be crazy not to look into this. And if you take the MSCI Asia, and you backtest it to 2007, so 15 years back, and then the MSCI Asia ESG leaders index actually outperforms the regular index by 37%, over those 15 years. And in my view this makes the case even more robustly to have more standardised rules and reporting around everything ESG.”
Another guest agreed, reporting that their digital platform had conducted studies that indicate the higher quality companies [that ESG-centricity tend to select or highlight] tend to make better profits and better investment returns. “So, for example, if we look at the various factors that affect equity performance in the past, like comparing factors like value, momentum, growth, ESG, and so forth, we actually found that there are that many factors that consistently lead to better returns. And quality is actually the factor that leads to most alpha versus the benchmark. And interestingly, ESG actually comes second. One can deduce that basically the better quality companies tend to have high ESG scores.”
And they explained that if you look at academic studies, corporate financial performance is highly correlated with sustainable ESG scoring of particular companies. “Also, if you think about ESG, it is also a risk mitigation too, with better corporate governance leading to better policies all round. And as governments and multi-lateral bodies are increasingly pushing green initiatives and policies, ther eis a risk of non-compliance in the future that do not get to grips with these issues.”
On the other hand, this expert added that a diversified basket of ESG-rated investments is wise, as many of the true leaders in terms of scores and credibility are smaller to mid-sized companies that carry more idiosyncratic company risks, because they are earlier stage.
In the past, going ESG-centric did not pay enough, but it is gradually, and will certainly pay off in the future
A banker observed that from a pure methodology point of view, it is actually extremely complicated to isolate what will be a theoretical, pure ESG performance. “To isolate performance as a pure ESG factor is a major methodological challenge,” he stated. “Secondly, if there was a direct correlation between ESG and performance in the past, we would not be in such a bad environmental situation as we are in today, as investors are really quite rational over time.”
In short, he explained that as ESG-driven capital allocation did not pay enough in the past, there was no major momentum towards its adoption. “But regulation is now coming along as well, and we are extremely confident that ESG will start to pay very strongly in the future.”
He explained that his bank is one of the very few asset managers and private banks to launch a natural capital strategy, which began some 24 months ago. “This natural capital strategy relies on the business model, directing capital towards the circular economy, the regenerative power of nature, and it has performed very well. However, it is skewed toward small and midcap, which have actually performed very well in the recent past and more recently have struggled somewhat. So, in reality, it is difficult to state that the performance of this natural capital strategy in the last 24 months was only due to ESG or sustainability.”
He also explained that traditional ESG factors tend to favour the environmental dimension and especially low carbon emitters. That, he explained, is the reason that the same names always appear high up the ESG rankings, such as Microsoft, Alphabet and others. But he said there should be higher ratings related to transitioning, in other words, companies that might not be low carbon yet, but that have a clear strategy and intention to contribute to decarbonisation.
“Typically, today,” he observed, “the ESG portfolio might be made up of large tech companies, which have a relatively low carbon footprint, but they might not actually have a definitive commitment to be carbon neutral by 2030. This is why you need, again, to go beyond traditional ESG metrics and traditional ESG approaches.”
As the digital assets universe expands, there are more and more ESG and sustainability advances set to emerge
A guest pointed out that just as the Coronavirus pandemic reduced carbon emissions, the development of the Metaverse will also reduce global carbon emission level in various ways. “For example, transportation and commuting,” they said. “We expect the Metaverse to gradually eliminate the need for a physical office, thereby reducing the frequency of commuting. In Metaverse, people will be able to do their work without leaving their home, which will naturally reduce their carbon footprint and at the same time, the Metaverse will provide people with an immersive leisure travel experience, which will also reduce the need of travel and therefore the carbon emission of the aviation sector. And from the industrial manufacturing side, let's take in the example for major brands, they have launched their virtual fashion collections, giving consumers the opportunity to dress up like avatars, themselves using their exclusive products and skins. In the future, we expect wearing your favourite designer clothes in the Metaverse maybe become commonplace, which will also help a consumer to escape the ecological damage caused by the fast fashion manufactured products.”
She explained also that games and toys in a virtual world may replace toys in real life, with a major positive environmental effect. “We have launched the first Metaverse ETF in Hong Kong, and we believe it will help in key areas such as carbon verification, carbon foot-printing, carbon capture, even the carbon trading, all of which can be implemented into Metaverse and in the real world. This will help contribute to the earlier achievement of the carbon peak and the carbon neutrality goals.”