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11 Mar Chinese Private Funds Explore the Road of ESG Investing, Tending to Risk Reduction
The Asset Management Association of China (AMAC) issued a self-evaluation report on green investment of fund managers on February 18, 2021. AMAC designed the dimensions and questions of a self-evaluation form and received valid samples from 37 mutual funds and 421 private funds, including 197 private securities investment funds and 224 private equity (PE) and venture capital (VC) funds. According to the statistics, as of the end of 3Q20, those institutions reported 83 green investment products independently, with a total asset management scale of RMB62.6bn. In terms of the return on investment (ROI) since the launch of the products, 79% of ESG and green investment fund products gained higher returns than the benchmark, 8% reported equal returns, and 13% were lower.
The report showed that both mutual and private fund managers had green investment practices. Among the 37 mutual funds, 24 funds transformed green investment research into green investment rating methodology or green investment product issuance, accounting for 65%, and eight ones could actively exercise shareholder voting rights to promote the green performances of the invested enterprises, accounting for 22%.
As for private funds, 96 private securities investment funds and 89 PE/VC funds engaged in green investment research. Among 197 private securities investment fund managers, 65 of them established green investment rating methodology and 40 built green information databases. Among 224 PE/VC funds, 48 funds set up green investment rating methodology and 40 built green information databases. Notably, 27% of the 224 funds carried out due diligence or post-management of green investment, implying a trend of focusing on risk management.
Top 3 driving forces of ESG indicator integration for Chinese private funds
Risk mitigation is the primary driving force for adopting responsible investment, and 85% of private fund managers choose it as their fundamental motivation to integrate ESG factors into their investment strategies. Echoing to this, a 2019 PwC report also showed that both general partners (GP) and limited partners (LP) globally cited risk management as the prime drive for responsible investment activities.
Regulatory requirement is the second drive with 65% of interviewees choosing it. The Chinese government is now supporting ESG related initiatives, such as environmental pollution prevention, rural revitalization strategy, and carbon neutrality. In December 2020, PBoC Governor Yi Gang indicated that the central bank was working on the revision of the eligible green bond project list, which would exclude projects like the clean utilization of coal and other fossil energy resources. After EU’s Sustainable Finance Disclosure Regulation (SFDR) took into force on March 10, it may lead the establishment of non-financial reporting frameworks of other countries and regions. (For more details of SFDR, please read EU SFDR Has Arrived: What it Means for All Investment Managers & Advisors)
Gaining alpha is the third drive for private fund managers to adopting ESG indicators into their investment. Most recently, the motivations of fund managers have been gradually switching from creating value for society and responding to regulators’ call to pay attention to the materiality impact of ESG issues on investment return. According to Fund Selector Asia, which conducted a survey with 542 institutional asset owners in the US, Canada, Europe, and Asia, 38% believed that integrating ESG factors into investments did help with the alpha generation. This reading is nearly double in percentage of respondents from the previous year.
Dominant barriers to private funds’ ESG investing practices
Global private funds are assessing ESG factors from two main sides based on checklist-questionnaires. One focuses on corporate performances, including business risk management, portfolio value creation, and more. The other is to understand a company’s compliance with ESG local and international laws and standards. However, there is a saying that ESG policies are no longer a simple tick-the-box exercise. According to the Asian Investor, investors want to understand how private fund managers are incorporating ESG metrics into their decision-making process. To meet investor demands, private fund managers still need to overcome the following obstacles:
Lack of awareness and understanding of ESG issues
A general problem of private funds in China is a lack of ESG issue understanding with insufficient clarity on which ESG issues are material. In particular, some are still in confusion as to the differences between corporate social responsibility (CSR) and ESG initiatives. In light of this, it could be regarded to some extent that fund managers are just adhering to various regulations and codes at present, rather than actually performing well regarding ESG related practices.
Lack of comparable ESG data and comprehensive measurement methods
A PwC analysis believes measuring the ESG related performances of private funds is difficult, as data is fragmented and there is still no standardized reporting framework for asset owners. According to AMAC, 75% of private securities investment funds and 90% of PE/VC funds built up their own ESG rating methodologies, while few of private funds adopted specialists and consulting services from external ESG advisors, making the ESG measurement results more subjective rather than objective and comparable.
Overall, the AMAC report indicated the development of green investment and the improvement of ESG integration in private funds’ green investment analysis. In the meantime, as private funds face some common challenges in green investing process, there is still room for them to improve its ESG information database and products. To learn how to improve your ESG data capabilities, feel free to contact us with firstname.lastname@example.org.