For years, Asia Pacific has lagged behind other regions in its awareness and focus on responsible investing. While there are pockets including Japan and Australia that are making progress, China and South East Asia are still dragging their feet in terms of regulatory oversight and individual company governance.
For years, Asia Pacific has lagged behind other regions in its awareness and focus on responsible investing. While there are pockets including Japan and Australia that are making progress, China and South East Asia are still dragging their feet in terms of regulatory oversight and individual company governance.
Launched over 27 years ago, Hong-Kong based fund manager Value Partners has watched the conversation around ESG evolve slowly, but steadily across the region. Norman Ho, the firm’s senior investment director for Asia excluding Japan, has three decades of industry experience, and says that more education and punishment are needed for Asia to catch up.
How has the concept of responsible investing changed in Asia, from when you first joined the industry?
It has changed a lot. Responsible investing was not in the Asia investment dictionary until a few years ago. Even though Asia started late, the speed of ramp-up is astonishing. Nowadays, in an annual report of an average company, the ESG section has become the longest, even longer than the MD&A (Management Discussion and Analysis).
From the sell-side, I have also noticed that they have been organising many awareness and teach-in seminars. Our institutional clients and fund consultants have also started to query us on these aspects during due diligence meetings, and I’m even seeing some sell-side analysts use ESG ratings to support their investment views, e.g. potential for P/E re-rating or de-rating because of favourable or unfavourable ESG scores.
Asian markets are relatively fragmented, and less transparent than other regions. How are you able to judge the quantitative and qualitative factors that build up a positive conviction in a company’s ESG standing?
The quantitative aspects are relatively easy to judge these days, due to numerous sources of financial data. It’s the qualitative, or non-financial data-driven aspects that are tricky and require much more effort on our part. Fortunately, our research team has a strong familiarity with the companies within our investment region, and this goes a long way towards building that qualitative conviction.
For example, I think that the environmental aspect of ESG relates more to the industry, rather than individual companies, and a test of management is how they drive their companies towards areas or strategies that are less harmful to our world.
Coal-fired power plant operators are a typical example. Over 90 per cent of China’s electricity is generated by coal fired power plants. China’s government policy is to gradually replace these fossil fuels with renewable alternatives, such as wind, solar, and hydro power. We have seen more forward-thinking management invest into these renewable energy projects, even though the short-term profitability and cash flow might not be ideal. It is a fact that power plants discharge toxic elements into the atmosphere, hence the amount and concentration is strictly controlled by regulatory bodies. We have also noticed that good management teams usually over-achieve in this aspect, i.e. discharge much less.
We are also happy to see that good management expends more effort to better the treatment of their employees, and society. Investors used to have an impression of Chinese factories operating like sweat shops. However, with the increase in general wealth and competition in labour, front-line factory workers now have a choice between working in factories within the same industry or work in newer verticals like sales, e-commerce delivery or operating their own small business. Hence, we notice that those companies with a long-term view provide a much better working environment for their workers. Modern factories with high value-added manufacturing have clean dormitories with air conditioning, tidy canteens, free WiFi, and a number of entertainment facilities, such as football fields or basket courts, karaoke lounges or even swimming pools. Yes, this will mean higher operating costs in the short-term, but a loyal and stable work force is essential if the entrepreneur is targeting the long-term.
From an investment performance perspective, we think corporate governance is one of the most important aspects when performing bottom-up stock selection. We have noticed that companies with good corporate governance tend to be rewarded with good total investment return. This comes in three aspects: 1) companies with disciplined management commit fewer mistakes and are better-prepared for upcoming risks, resulting in higher and more sustainable long-term profit growth; 2) their better transparency, disclosure and solid articulation of development of long-term strategy is rewarded with higher P/E multiples; and 3) a higher earnings stream at a higher valuation multiplies together into higher share appreciation potential.
What is the biggest hurdle to improving Asia’s ESG performance: corporate/social culture, regulations, or investor understanding?
The biggest hurdle comes from the fact that some of the listed companies do not yet see the benefit of adopting good ESG policies, which can translate into stronger share prices and thus lower cost of capital. It might be that their managements do not see the need for increased capital for business expansion, or that some small companies lack the resources to practice ESG policies. Others, unfortunately, simply don’t care about minority shareholders, and even adopt an “I win, you lose” mentality.
What developments are still needed to better engage management and ensure a productive dialogue for the benefit of investors?
Simply put – education and punishment. All businesses are profit-seeking; if they are rational, then they will select and stick to the path that brings them to their financial and business growth. They should be educated on the fact that there is a clear link between corporate governance and long-term financial return. This education can be executed both externally and internally. External bodies, such as exchanges or regulatory bodies, can actively promote it. Internally, their IR department or finance department should have dedicated professionals to push it. Auditors can play a part as well.
