Will Asia-Pacific catch up with Europe and the US when it comes to ESG adoption? We asked four GPs what they think are the most pertinent trends of ESG investing in Asia-Pacific
Will Asia-Pacific catch up with Europe and the US when it comes to ESG adoption? We asked four GPs what they think are the most pertinent trends of ESG investing in Asia-Pacific
Confronted with the human costs of the pandemic and the ever-pressing climate change emergency, investors are increasingly seeking out portfolios that integrate ESG (environmental, social, and governance). Yet, despite the fact that at least $3tn of institutional assets are now tracking ESG scores globally, investors in Asia-Pacific are way behind those in markets with strong frameworks and regulatory support for ESG. Preqin data shows that just 14% of private equity firms in Asia-Pacific are over the median transparency metric of 5%, which lags that of the US (46%) and Europe (54%, Fig. 1).
With that said, ESG participation is growing in Asia-Pacific; Preqin tracks 43 firms that score above the 50% disclosure mark for transparency. This proves there is a good number of outliers who are committed to explicit documentation, which speaks to their participation in ESG.
Indeed, investor demand for ESG commitment is rising in recognition of the higher risk-adjusted returns and long-term sustainable alphas associated with ESG-integrated portfolios. According to a global Preqin investor survey conducted in November 2020, 81% of private equity investors have some ESG plan in place, and 78% believe that investor demand is what’s driving more fund managers to develop ESG policies.
Government support for ESG in Asia-Pacific has also ramped up over the past year. In Q3 2020, China, Japan, and South Korea all pledged to achieve complete carbon neutrality by 2050-2060. In March 2021, the Chinese Government put a priority on climate change in its 14th five-year plan, outlining a 18% reduction target for “CO2 intensity.” Earlier this year, Hong Kong’s stock exchange regulator (HKEX) and Singapore’s stock exchange introduced ESG-focused listing requirements and sustainability reporting guidelines. The national pension and sovereign funds in China, Hong Kong, Malaysia, and Thailand have also incorporated ESG into their investment strategies.
For GPs still on the sidelines, the increasing evidence that ESG is not just charitable but also profitable should motivate them to act. Between impact funds, funds managed by GPs committed to ESG, and funds classified neither as impact funds nor as funds managed by ESG-committed GPs according to their vintage years, Preqin found that the first two types demonstrated higher performance. IRRs since inception for vintage 2016 impact private capital funds outperformed the other two types, while vintage 2011 private capital funds managed by ESG-committed GPs outperformed the third fund group by an average of about 2.4 percentage points (Fig. 2).
What’s more, when investors commit to an impact fund or a fund managed by a GP committed to ESG, Preqin finds they have a lower dispersion rate, which means less risk in the manager selection process. Investors can thus have greater confidence in its performance.
What are firms in Asia-Pacific currently doing to integrate ESG, and what trends are forming for the future of ESG investing in Asia-Pacific? As part of Preqin’s Expert Voices series, we spoke with four GPs to find out.
JK Paul Yang, Head of Multi-Asset at VI AMC Korea:
Since ESG was first developed and adopted in Western markets, they obviously lead the pack on ESG practices and investments. However, ESG has become a global phenomenon in the wake of the pandemic, which provided a perfect test bed for countries and companies across the globe in terms of how to cope from an ESG standpoint. Asia-Pacific has begun to catch up with the trend and it also has more potential for growth in ESG investments.
One of the biggest challenges facing the adoption of ESG in Asia-Pacific markets is the belief that investing in companies that are doing good does not always translate to good returns. However, fund managers can rely on empirical evidence that shows a high correlation between higher ESG scores and better returns, especially for equities. Hence, there is a need to overcome that misconception and educate investors that with the right practices and processes in place, ESG investments can provide sustainable alpha.
Our firm is currently working with local ESG data providers to build models and screens that incorporate the firm’s ESG investment philosophy. At the firm level, we have an ESG investment committee in place to help us make strategic investment decisions. Although the pandemic has piqued interest in ESG, demand for ESG investing is here for as long as critical issues like climate change remain a long-term global priority. ESG will become a mainstream asset class and strategy – it will not be surprising to see the asset management industry integrating at least 50% of its assets in ESG five years down the road.
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Chris Botsford, Co-Founder and Joint Chief Investment Officer at ADM Capital:
ADM Capital is well into its second decade of integrating ESG considerations in its investment cycle. In 2008, the firm was the first Asian investment manager (excluding Japan) to become a signatory to the UN Principles for Responsible Investment (PRI).
Since then, we have witnessed significant improvements across Asia-Pacific in how investors grasp sustainability issues, such as protecting the environment, using natural resources more efficiently, supporting wellbeing at work, and engaging positively with stakeholders. We also see improvements in governance, which generally result in revenue growth and cost reductions for a company.
The COVID-19 pandemic raised fears that climate-related challenges would be ignored. This was not the case. Instead, we see companies, investors, and fund managers realizing that financial considerations alone are not enough. The pandemic has also highlighted the importance of looking ahead, recognizing the megatrends at play, and preparing for every eventuality.
Irrespective of the specific terminology used, organizations, even the smaller ones, are building environmental resilience and shifting toward greater positive societal impact. Some changes are voluntary, driven by leading companies and industry platforms, while others are necessitated by new local regulations, either by Europe-based investors operating under the EU Taxonomy, or by Development Finance Institutions and other Multilateral Development Banks.
Three globally relevant challenges dominate in the diverse and connected Asia-Pacific region. First, a growing number of affluent customers want to see supply chain transparency and are reluctant to further threaten our planetary boundaries. Second, new technologies can either make or break an organization rapidly and must be evaluated with care. Third, inequalities have been exacerbated by COVID-19 in the short term in Asia-Pacific. We expect climate change to continue this negative trend in the medium to long term.
On the positive side, we expect that companies will continue to adapt to market and regulatory opportunities, regulators will support the protection of the environment and of people, while investors will work with companies to improve the integrated measurement of financial and extra-financial data. We believe such monitoring will eventually show that internalizing externalities is both profitable and delivers impact.
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Jaclyn Seow, Head of ESG & Impact at Openspace Ventures:
Openspace Ventures’ approach to integrating ESG into our investment process is detailed in our inaugural sustainability report released earlier this year. As an early-stage tech investor, most of Openspace's value-add comes from enabling a clear understanding of the value of ESG management and helping companies to prioritize their ESG efforts given limited resources. We advise on material ESG issues and help identify gaps and opportunities. For instance, we help to identify and prioritize ESG certifications, such as ISO27001, that could increase brand and market value, develop policy guidelines, conduct ESG training sessions, and maintain a network of service providers who help our portfolio companies establish ESG best practices.
In the 2018 GSIA survey, about two-thirds of sustainable investments fell under the exclusionary screening category. I expect more asset managers to evolve beyond this toward more sophisticated ESG integration, with systematic due diligence and post-investment monitoring. Asset owners will increasingly demand this through their manager selection criteria. You can already see signs that ESG integration is inevitable: KKR bought the world’s largest sustainability consultancy ERM at a $3bn valuation in May this year, and JP Morgan bought OpenInvest, a fintech platform which allows clients to create values-based portfolios, in June.
The green economy is burgeoning with investment opportunities as we race toward 2030. For instance, solutions aimed at decarbonizing agriculture through scientific innovation as well as supply chain efficiency, combined with those aimed at making cities less resource intensive, are on a strong uptrend in Southeast Asia. The developing world will also increasingly see technology play a part in solving widespread social challenges, including access to basic services such as health and education. The digital economy in Southeast Asia is expected to surpass $300bn in 2023, which will account for almost 10% of the region's GDP. These joint forces are going to pull more investors – including tech investors – into thematic ESG investing. AUM in sustainability-focused funds is now close to $2tn; while the jury is not yet out over whether these funds truly perform better than non-sustainability-focused funds, I do not see interest abating in the near future.
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Evan Hattersley, Managing Director at Pacific Equity Partners:
We see the rise of ESG as a global movement. Over the last decade, it has shifted from a compliance-based activity to become a central component of successful investing across all stages of the investment management lifecycle, from acquisition to exit. While large public sector funds in Europe were early adopters of ESG practices, we have seen investors and fund managers across Asia-Pacific move quickly to implement similar programs.
The pace of change has increased significantly since the onset of the pandemic, as investors have witnessed the impact of a remote exogenous risk on markets across the globe. This has heightened the current focus on ESG, and we view this as a continuation of a longer-term trend toward increased convergence of ESG and financial outcomes.
One challenge that managers face, however, is how to set, track, and report on ESG programs given the breadth of activities they encompass. In recognition of this, Pacific Equity Partners has recently created a new Director of ESG role to drive the ongoing development of our ESG program and provide a focal point for our firm, portfolio companies, and investors. As part of our ESG program we are currently incorporating bespoke, asset-specific targets that are explicitly linked to management team incentives, as well as increasing the tracking and reporting of ESG activities across our portfolio.
Looking beyond these communication challenges, we see a significant opportunity for well-developed ESG programs to drive both positive ESG and financial outcomes. The financial impact will be delivered through growth in earnings, as products and services with strong ESG aspects are increasingly valued by customers; as well as higher market multiples, since companies with strong ESG credentials are increasingly sought by investors.
Learn more about the rise of ESG in alternative assets with Preqin's dedicated ESG content hub.