Sustainable Investment in China | Investors to Consider Non-Financial Metrics in ESG Investments

Environmental, social, governance (ESG) issues are crucial for developing sound sustainable business in an emerging market like China. But, to be effective investors need to know what to invest in and what to look for. They need to look beyond the financial metrics to understand the ESG performance of investments. Last year BSR’s research highlighted four specific ESG issues that are of particular importance to investors in China: lack of governance, misleading marketing, substandard product quality, and waste-water pollution. These factors are directly affecting stock prices.

On October 26 at BSR’s 2012 Conference in New York we hosted a panel session with veteran investors Miguel J. Martins from the Sustainable Business Advisory Department at the International Finance Corporation, Paulo Corchaki, Chief Investment Officer at Itaú Asset Management, and Seiji Kawazoe, Associate General Manager, Sumitomo Mitsui Trust & Bank to discuss current issues, themes, and trends that are particularly important for investors interested in emerging markets like China, Brazil and India. For these key countries, the investment risks are heightened by political, economic and social instability so investors interested in these emerging markets must take an acute look at extra qualitative and quantitative ESG information.

This panel raised several key issues. Firstly, due to the lack of regulatory enforcement in emerging markets, there is an even more robust business case than in developed markets for looking beyond financial metrics and considering ESG factors in investment decisions. Integrating ESG criteria into valuations can better account for risks and opportunities. Secondly, understanding different stakeholder landscapes and how they provide opportunities for companies is crucial. In the financial services industry for example, one avenue for growth in emerging markets will come through reaching bottom-of-the-pyramid consumers with financial products (responsibly sold of course). To do this will require partnering with civil society to provide educational initiatives. Martins gave the example of a bank being unable to sell a single financial product to a farmer if that farmer has less than a rudimentary understanding of money. The challenge, according to Martin, is how various players in the space begin interacting and building collaborative solutions.

According to Corchaki, middle-income earners are also a key target group in emerging markets and they represent an opportunity to tap into a growing population who are increasingly aware of—and driving—ESG issues. Environmental Leader magazine published research by Green Gauge Global Research which found that the proportion of consumers who factor environmental protection into their purchase decisions grew six percentage points in China, and five points in Brazil from last year.

In addition, Kawazoe stated that companies performing well according to ESG metrics are also financially out-performing the market in general. ESG performance is correlated to financial performance. Companies will make further ESG progress as they understand investors’ interests.

“ESG is important. It’s not a fad. It’s not the flavor of the decade. It’s here to stay. I would invest much faster in Brazil and China than in Portugal, Greece, or Spain. ESG permeates the entire world, and it has to do with all of us” —Miguel J. Martins, International Finance Corporation

Challenges with understanding ESG performance

The panel went on to discuss some of the challenges faced by investors like them. Corchaki remarked that moving from qualitative to quantitative evaluations is proving to be difficult and industries including mining, oil, and steel are receiving lower valuations, according to ESG metrics. Itaú is going sector by sector to understand how ESG affects company valuations. Industries including mining, oil, and steel are receiving lower valuations, according to ESG metrics.

“We made a correlation between good credit and quality management and governance. In Brazil, companies are…becoming more transparent with their balance sheets related to ESG issues. But they do not yet know what is important for investors.” —Paulo Corchaki, Itaú Asset Management

According to Kawazoe, field research that goes beyond company reports is going to play an increasingly important role to develop an understanding of a company’s historical ESG performance

Given the acute awareness investors need to have now what will ESG look like ten years from now?

The BSR session concluded with a summary from Martins who claimed that tremendous investment opportunities exist in infrastructure and innovation: Infrastructure opportunities include advanced distribution models to deliver vital resources like water and food. Innovation opportunities relate to technology that will further change and improve access to services in emerging markets. Finally, he stated that companies have an opportunity to communicate more ESG information through reporting to become more transparent and to attract new investors.

Kawazoe offered his assessment of the next five to ten years by explaining that ESG will be further integrated into business models through rigorous data management. He encouraged the audience to invest now, since companies with robust ESG management will yield good returns.

In summary the speakers agreed that innovation in social, environmental, and governance (ESG) is now coming from emerging markets but that there is a necessity to look beyond financial metrics, since there are weaker regulations and enforcement in emerging markets. Integrating ESG criteria into valuations can better account for risks and opportunities.

To read the full summary of this session please click here