Can investing in China meet ESG criteria?

Katie Royals, 12/05/2021

ESG or ethical investing is an ever-growing focus for wealth managers and navigating these demands is becoming a key responsibility. Meanwhile, the rise of China has been an investment mega-trend for many years.

But what happens when these two themes collide? Do human rights issues and unfavourable working conditions make ESG investing in Chinese companies impossible? Or does the country’s commitment to tackling climate change and its ambitious target of being carbon neutral by 2060 in fact make it an ideal place for morals-led investors?

John Ewart, a fund manager at Aubrey Capital Management, told thewealthnet it’s important to remember that you are not investing in the government, despite perceptions of state infiltration in most businesses.

“We’re investing in companies and what we’re focused on is the consumer.”

The Chinese consumer sector barely existed 25 years ago, he says, providing a lot of opportunities for growth. And that’s not the only thing that’s changed quickly.

Frank Tsui, managing director and head of ESG investment at Value Partners Group, a Hong Kong-based fund manager, said the ESG investing landscape has changed rapidly over the last 18 months.

Most companies are now willing to disclose ESG information even though this is not yet mandatory and companies are becoming much more accessible.  

It is still hard to assess State Owned Enterprises (SOEs), but due to their lower yields these tend to be a less attractive option for investors regardless of their ESG credentials, Mr Tsui said.

While private companies are becoming more open, there can be an issue with the quality of what they disclose.

Reporting on ESG is “something of an art”. Companies that know how to play the system will nearly always score highly, said Ronald Chan, the founder and chief investment officer of Chartwell Capital, another Hong Kong investment manager.

Given ESG reporting is relatively new for a lot of Chinese firms, many score lower than they should, simply because they do not know how to game the system.

For example, many firms do not know the Carbon Disclosure Project exists, despite it being likely this will be a key part of reporting going forward.

This all means there are a lot of overlooked companies, Mr Chan believes.

For this reason, he said he does not look for companies that score highly on these measures, but companies that get low scores that should score higher.

"We can’t blame senior management for not knowing what they don’t know. But, we should be working with them to help them understand."

When deciding which companies are overlooked and could do better in terms of ESG, Mr Chan said a lot of it comes down to culture. He looks for firms that are trying to do the right thing, even where there is still room for improvement.

In terms of accuracy of information in financial reports, Mr Tsui said the data he receives from the company itself is “purely for reference”.

Like Mr Chan, he acknowledges a lot of Chinese companies are not necessarily up to international standards yet. Instead, he he looks at what progress has been made in the past 6 to 12 months.

This is a labour intensive process. His company started with two or three dedicated ESG analysts, but now such processes have been implemented across the whole team.

Mr Tsui believes this will pay off in the long term and will have a positive impact on shareholders, both ethically and financially.

However, Mr Ewart stressed that no country is without faults on the accuracy of financial reporting.

“Just look at Wirecard,” he said. “Where there is a desire for fraud it will happen.”

But, when looking at large Chinese companies, it’s worth noting the majority are audited by the same large international firms as companies in any other country are.

Within Mr Ewart’s firm, they look at up to 300 companies in China which they believe can meet ESG criteria.

A lot of these companies are also very important for developing sustainable solutions that will help tackle climate change. Chinese companies appear to be ahead of the game on electric vehicle technology and have developed solutions that re-charge batteries far quicker.

Mr Chan acknowledged that Chinese companies are not fully perfect.

“There are definitely bad apples, but it’s a global effort. Everyone has to start the conversation.”

Mr Tsui acknowledged that China is “still far behind more developed countries,” and there’s a lot of work still to be done. But, visible improvements are being seen, he stressed.