As local oil trading firm Hin Leong winds up after nearly six decades of operation, it is difficult not to see this moment as the end of an era. It marks oil magnate Lim Oon Kuin’s fall from grace as he struggled to ensure sufficient liquidity for his trading operations, thereby triggering the abetment of forgery charges he now faces. To some extent, the episode is also a sign of how the wider investment community is no longer eager to invest or extend funding to industries seen as going against the wider push towards sustainability.
The acronym “ESG” refers to an organisation’s environmental, social and corporate governance, which are key metrics of a firm’s sustainability. Amid increased awareness of climate change, such concerns have taken on renewed prominence as humanity has only around a decade to prevent irreversible environmental damage.
Firms now realise that their profits mean nothing if the planet is destroyed. Fidelity International’s 2021 Analyst Survey found that more than half (54%) of respondents had a majority of their firms placing greater emphasis on implementing and communicating ESG policies in 2020, compared to 46% in 2019.
“Climate change has become a risk that is too important for investors to ignore,” says Monetary Authority of Singapore (MAS) managing director Ravi Menon at the IMAS-Bloomberg Investment Conference on March 9, 2021.
With economies and societies expected to radically transform in response to this challenge, investors must account for potential changes in asset values. Menon cites an estimate by The Economist Intelligence Unit (EIU) that US$4.2 trillion ($5.7 trillion) of global financial assets are at risk from climate change.
With 2021 shaping up to be the “Year of ESG”, Singapore’s investment management industry is busy getting on board. According to a survey done by the Investment Management Association of Singapore (IMAS) in 2020, 86% of investment managers see ESG factors driving industry growth — a significant increase from 68% of affirmative responses in 2019 and just 37.5% during the inaugural survey in 2017.
“Ethical investing started coming in because [people] began to realise that certain industries were unethical and would lead to social harm,” says IMAS spokesman Victor Wong, whose day job is head of Asia-ex Japan ESG, UOB Asset Management (UOBAM). Over time, he says, attitudes have shifted. From identifying companies that do not just passively do no harm, there is now a proactive search for companies that “do good”. This has led to growing interest in impact and thematic investing in Singapore to reward businesses that contribute to collective sustainability.
The logic of altruism
But this ESG turn has not been pursued out of pure altruism. “Some recent research has found a strong correlation between market performance and ESG ratings, for both equity and fixed income portfolios. During the early weeks of the Covid-19 crisis, there was also some evidence that major ESG funds were able to outperform broad indices like the S&P 500,” observes Menon. Ultimately, says Wong, outperformance is the language that the investment community understands best.
The reason for this outperformance is that ESG investing prices in long-term ESG risks that are not typically considered under older valuation methods. Wong notes that investing without an eye on ESG fails to price in both the full cost and long-term view of a position. ESG investing better detects high-quality and resilient plays that are both sustainable and competitive in the long run.
Institutional investors like UOBAM, says Wong, are moreover bound by their mandate to consider long-term investment goals and megatrends such as climate change. “It is our fiduciary duty to allocate capital to sustainable investments. We invest for generations — our clients rely on us for that,” he explains.
Demand for ESG investment has gained traction in developed Western capital markets and has caught on among local retail investors too. Wong notes that the latter are now more aware of the importance of ESG, especially with first-hand experience of climate change events like unusual cold spells in tropical Singapore. The government’s $100 billion plan to combat climate change may also have raised investors’ eyebrows; Parliament declared climate change “a global emergency and a threat to mankind” in February 2021.
With countries pushing towards net zero targets, a rising tide of capital investment has created a “wall of money” around green investments. This creates significant opportunities for investors to buy into the global ESG wave, with the Biden administration already promising a US$2 trillion plan to tackle climate change. Unfortunately, says Menon of MAS, not enough of global wealth is being channelled to meet the goals of the Paris Climate Agreement.
The ESG investment gap is particularly large in Asia — a key battleground in the war on climate change. “Asia accounts for almost half of global greenhouse gas emissions. It also bears the brunt of economic losses from natural disasters — and climate change will amplify the impact,” Menon tells the IMAS conference. Asia needs US$1.7 trillion of investment in sustainable infrastructure until 2030, with regional ESG investment quickly gaining on global leader Europe.
The art and science of valuation
So how does one value an investment based on ESG metrics? At one level, this involves conducting fundamental analysis on an ESG play, but from a sustainability perspective. The “G” (governance) component of ESG is in fact nothing new, Wong tells The Edge Singapore, with investors having long assessed the soundness of a business based on factors such as board composition, organisational structure and management efficacy.
The real innovation, however, is suitable pricing of “E” (environment) and “S” (social) into valuations. From his experience at UOBAM, analysing these factors involves going a step further than conventional fundamental analysis, diving deeper into the weeds of specific ESG issues. For instance, if one is evaluating a coal company, it is key to understand how that firm intends to cope with a future where global energy markets may reject it as a “dirty fuel”.
“I would have to then...factor this into the long-term outlook for this company and then attach an appropriate risk premium to this company,” says Wong, who would then use this to outline a more nuanced and comprehensive target price and investment rationale for said company. Much of these insights are obtained not just from open-source intelligence, but also personal, ground-up insights derived from actively engaging with firms.
Such engagement is in fact often a process of education as well, with investment managers at UOBAM regularly sharing ways in which firms can improve ESG resilience. Fidelity International is in fact a founding member of the IIGCC Net Zero Asset Managers initiative — a coalition of international asset managers dedicated to achieving “net zero” emissions by 2050. Part of the grouping’s work is to actively work with clients on decarbonisation goals.
“We are not going to get to a net zero future if you only own low carbon emitters,” says Jenn-Hui Tan, global head of stewardship and sustainable investing at Fidelity International. “You shouldn’t not invest in high carbon emitters. What you should do is invest and use your influence...trying to push them on a formal transition pathway,” he explains, with divestment from a company only an option should an investee prove unwilling to improve.
And ground-level engagement is in fact useful in a region like Asia, where disclosure of ESG data is relatively patchy. Through regional offices across Asia, UOBAM can personally reach out and start conversations with local firms to fill in the gaps of scarce and incomplete ESG data. Consequently, more informed conclusions can be drawn about a company’s ESG situation than would be possible via crude detective work performed on these data sets.
Beyond human intelligence, however, emerging technologies like natural language processing have allowed UOBAM to track the rapid occurrence of ESG controversies (e.g. oil spills) in real-time. This qualitative data can subsequently be coded and quantified, allowing for the generation of a quantitative ESG score. Should these scores fall below a certain threshold, investment managers then review an asset’s investment case and risk premiums.
A more fundamental challenge, however, is the difficulty in defining the criteria for what constitutes ESG due to the fragmented nature of present regulations. “The lack of consistency and transparency affects investors’ ability to monitor progress in emissions reduction or measure outcomes in sustainability,” says Menon. This lack of clarity could give rise to “greenwashing”, where businesses unscrupulously take advantage of these vague definitions to misrepresent their actual ESG position.
MAS is thus moving to clarify the definition of ESG both at home and abroad. It has released environmental risk management guidelines for local financial institutions and is looking to develop a clearer taxonomy of what constitutes green activities. It is also reviewing the Singapore Stewardship Principles pertaining to environmental issues and working with Asean and global regulators to shape internationally consistent ESG reporting and disclosure.
Buying green
Green assets popular in Singapore now, say Wong, tend to be those that blend sustainability and liquidity. “Cash management products that have that element of ESG incorporation, or fixed income funds that also incorporate ESG are what investors like at the moment,” shares the IMAS spokesperson. Equity funds that invest based on ESG themes are also popular ways for investors to ride the sustainability wave.
A popular theme is the UN Sustainable Development Goals (UNSDG), 17 global goals designed as a roadmap towards a more sustainable future. Malaysian and Indonesian investors are also keen on combining ESG with Shariah investing. According to Wong, investors like complimenting negative screening via Shariah compliance with a more positive approach via ESG, which seeks to find firms that reach new heights of sustainability. China is an especially attractive ESG market.
Flora Wang, director, sustainable investing, and assistant portfolio manager at Fidelity International, highlights that China has been the largest contributor to global renewable energy installation from 2017–2019 and accounts for nearly 30% of the world’s renewable energy capacity — almost triple that of the second-placed US. To achieve its carbon neutral target in 2060, China is expected to require RMB138 trillion ($28 trillion) — over 2.5% of its GDP per annum — from 2020–2050 for its energy systems alone.
The Singapore government’s decision to issue more “green bonds” as part of Budget 2021 has been well-received by investment managers. “At this moment in time, quite a bit of [these bonds] come from North Asia — particularly China, for example. They tend to be concentrated on certain sectors,” notes Wong, who celebrates the diversification of the Asian green bond galaxy. Surbana Jurong’s recent sustainability-linked bond issue in February, for instance, was Southeast Asia’s first public sustainability-linked bond denominated in Singapore dollars.
“The transition to a net-zero economy is the greatest collective endeavour humanity must undertake in the decades ahead. How capital is allocated to support this endeavour will be critical to the outcome. As owners and stewards of capital, you have a great responsibility — to direct investments to activities that promote sustainable development,” Menon tells investment managers. If more financial institutions pay greater attention to ESG, the entire financial industry will be all the more resilient for it.
