Although Chinese capital markets provide diversification benefits and attractive alpha opportunities for global investors, substantial challenges on the sustainable investment (SI) front have made investors cautious at the same time.
According to the research from Willis Towers Watson, a total portfolio approach would allow global investors to capture the risk and return benefits of Chinese assets in their portfolios and still maintain the same level of environmental, social, and governance (ESG) performance.
The total portfolio approach considered each risk factor in aggregate across the whole portfolio rather than just within each asset class and this framework allowed investors to reduce exposure to assets that had negative sustainability characteristics elsewhere in the portfolio and increase allocation to Chinese assets that had better ESG momentum and better overall risk and return potential.
The study also revealed that by using a total portfolio approach and active management of Chinese assets, investors could gain the long-term diversification and expected return benefits from adding the Chinese assets without a negative impact on their overall sustainability profile.
“Sustainable investing is not just about properly integrating ESG-related information for risk management purposes. It is also about recognising that long-term ESG-related themes, such as climate change, can create return opportunities,” Liang Yin, director in WTW’s investments research team and China project lead, said.
“China has in recent years emerged as a world leader in funding and developing technologies to combat climate change and its net-zero pledge will greatly influence economic and climate policies in the decades to come. Moving forward, we expect China to be a major source of climate change driven investment opportunities.”
According to the research, skilled active management could also significantly reduce risk exposures related to poor ESG practices that sometimes can be encountered in China. However, when selecting investment managers, investors should look for a strong emphasis on their ESG integration and stewardship practices.
“We strongly believe that skilled active management should be front and centre of any institutional implementation solutions to access China. Given the current state of China’s sustainable investment development, we do not recommend a blanket allocation across Chinese assets,” Leslie Mao, WTW Australia senior investment consultant said.
“Accessing China’s large and rich opportunity while navigating its complex sustainable investment landscape can pose a significant governance challenge for many asset owners. However, the benefit of doing so outweighs the risk and incremental costs.
“Asset owners do not necessarily have to have a presence in China or internal staff who can speak Chinese, but they do need to have well-resourced local partners on whom they can lean when making allocation decisions and selecting managers.”