There’s a Big Opportunity for ESG in China
Chinese companies may lag behind on environmental, social, and governance ratings, but last year’s returns show the huge potential of ESG leaders in China, according to Cambridge Associates.
Chinese companies have lagged behind in environment, social, and governance performance, but they are catching up with the global investment trend as they try to attract foreign capital.
Currently, the world’s second-largest economy ranks near the bottom for ESG performance, placing 47th out of the 50 countries in the MSCI All Country World Index as of June 30, according to a recent report by investment and consulting firm Cambridge Associates. On a scale of 0 to 10, companies in top-performing countries like the U.K. and Australia achieved a median score of 7.1 or higher, while those in China only scored a median of 2.9.
Cambridge Associates points out that the country’s disconcerting ESG performance is largely due to low levels of ESG disclosure and a lack of standardization of reporting metrics among domestic companies.
But more Chinese companies have started to emphasize ESG, the report added. From 2009 to 2018, the percentage of Chinese companies in the Shanghai-Shenzhen CSI 300 Index that have voluntarily disclosed some level of ESG data rose from 43 percent to 82 percent.
“This is in part due to the opening of China’s markets, which has helped Chinese companies to recognize the benefits of information disclosure in attracting foreign capital. It also follows government policy pushes toward greater transparency in disclosing ESG risks,” the report said.
The companies with the worst ESG ratings tend to be the smallest companies, according to the report. While close to half of the companies in the MSCI China Index are “ESG laggards” — defined as having an ESG rating of B or below by MSCI standards — they only make up 17 percent of the index’s weight.
The sectors with fewer ESG laggards included finance, consumer discretionary, healthcare, and real estate. The only Chinese company with the highest AAA ESG rating by MSCI was Yadea, a two-wheel electric car maker established in 2001. Notable names in the AA rating group included JD Health International, Lenovo Group Limited, Suning.com Co., and Xpeng.
These and other high-rated companies have dramatically outperformed those with worse ESG ratings, according to the report. Returns for companies with AAA-AA ratings reached 82.5 percent in the past year ending June 30, while companies with ESG ratings of B or below only generated a 17.5 percent return.
Because most Chinese companies have yet to catch up with international ESG rating standards, Cambridge Associates suggests that investors interested in China should avoid a “pure ratings-based approach” when it comes to ESG evaluation.
“Active strategies that invest in China via an ESG approach may need to customize their assessment rather than rely on a global framework,” the report concluded. “In this respect, we see that managers that have the ability to dedicate resources to focus exclusively on China and apply a local lens to identify material ESG issues may be in a better position to navigate risks.”