'ESG is not that difficult' – Cathay Financial CIO on how the insurer invests sustainably

With today’s strong returns across asset classes, institutional investors like Cathay Financial Holdings have no excuse not to explore meaningful sustainable investing deals, Chief Investment Officer Sophia Cheng said.

Five years ago, when the conversation about green bonds first started, investors were worried that they had to sacrifice returns, she said.

“After 2022, interest rates have come up so much. Almost all the fixed-income assets we see offer a much higher return than in 2021 … So what are you waiting for, right?” she said in an exclusive interview during the AVPN Global Conference 2024 in Abu Dhabi on April 24.

Equity markets today are volatile, and global liquidity has pushed up valuations, she admitted. But that only means investors must put in more effort to find the best timings and valuations to make investments.

“Compared to 2021, everything has much better returns. So you can always find areas with better returns to compensate the overall portfolio. … I think there is no excuse for us not to explore, to support meaningful deals,” said Cheng, who is also the chair of the Asia Investor Group on Climate Change.

Cathay Financial Holdings is one of the largest financial groups in Taiwan and is the parent company of insurance, financial and securities subsidiaries including Cathay Life, Taiwan’s flagship insurance company. The holding company has around $400 billion in assets, of which 60% is in insurance.

The company was an early adopter of responsible investment principles, having created its responsible investment team in 2014. It is also a part of many climate and engagement initiatives and is committed to a 2050 net-zero target.

Aside from cash and derivatives, the company’s portfolio is 100% ESG-integrated, as defined by the Global Sustainable Investment Alliance, which means it considers ESG factors during its investment analysis and decision-making processes to improve risk-adjusted returns.

Most of Cathay Life's portfolio is in international bonds (61.8%), followed by 8.1% in domestic bonds, 6.6% in domestic equity, 5.6% in international equity, 2.6% in cash and equivalents, and the rest in loans, real estate and other assets.

“When we do responsible investments, we like to learn from global practices (such as) the Global Sustainable Investment Alliance, which provides statistics on U.S., Europe, Australia, and Japan markets, for example,” she said. Cathay Financial also benchmarks itself against the United Nations Principles for Responsible Investments and local stewardship principles.

The firm identifies certain types of business it will not invest in, such as controversial weapons, sex trades and gambling, and classifies some sectors as “sensitive” industries such as tobacco, fossil fuel or other high-emitting companies.

Sensitive companies are those that require more research, engagement and monitoring before Cathay decides to invest in them, Cheng said. “Besides financial return, we look at how the company performs in terms of ESG, climate action, and if they have controversial issues. So we categorize these investment targets as high, mid or low risk. After we lend the loan or do the investment, we need to monitor their progress,” she said.

Cathay is active in engaging with its investee companies, she added. Companies sometimes do controversial things because they genuinely don’t know better, she said. “So we pass on international trends to them, we share our experience and we tell them why it’s important to (change their ways).”

“They decide their future. If we have a couple of years, we engage and they don’t care, then we can divest. The purpose of engagement is to encourage them to change. We want them to transition rather than disappear,” she said.

The company also expects all its external managers to be signatories to the UN PRI or local stewardship principles. Taiwanese companies, for instance, cannot be PRI signatories because Taiwan is not recognized as a member of the U.N., but the Financial Supervisory Commission has released stewardship principles to which local firms can adhere. Cathay has 10% to 20% of its portfolio managed by external managers, depending on market conditions.

“External managers need to answer our ESG questionnaire … because unless the fund guidelines are exactly identical to yours, it can be challenging to monitor the day-to-day portfolio movement,” Cheng said. “So we talk to these asset managers to know their values, how they do integration, and whether they follow our principles.”

This also applies to hedge funds and private equity firms, which have gone through some positive change in recent years, she observed. “Five years ago, right before COVID, I was at an alternative investment conference, and they were talking about ESG. They said ‘ESG is for mutual funds, not for us,’ and I responded ‘if you say so, you may have risk in your future and may lose your clients,'” she recalled.

“Now, they do care more,” she said.

Cheng’s team is now exploring blended finance deals, where two or more organizations invest in the same projects and are each willing to accept different returns across investors.

“I want to find the opportunity to do one because I think it's so meaningful. And these days, you have public-private cooperations,” Cheng said. For example, if a bond defaults, one party could absorb the loss. In another case, some development funds involved in the investment could say they are willing to absorb 75% of the loss.

“That means if you have a nonperforming loan or bad debt tolerance target of 1%, now you can tolerate it to 4% because someone else absorbs the 3%. Such collaboration is a good idea. We are seeing more and more cases so I am quite optimistic. Three years from now I hope to have more of such deals in Asia,” she said.

Sustainable investing or ESG integration is not difficult to get started with, she added. Investors can start with a list of themes or concerns they want to avoid. Some investors say they do not invest because of a lack of data, but data availability should not be a reason not to do the right thing, she said.

“We don't need precise data to make a decision. Precise data methodologies or frameworks are for us to disclose what we are doing and for us to have a tool to (conduct) the analysis,” she added. Investors do not need to wait for “a perfect database or perfect global framework” to make good decisions, she said.

“ESG is part of our investment process. ESG reflects our sense of value,” she said. “And it's our declaration to the world to say what type of money we don't want to earn and what type of money we will use to fulfill our duty to influence our investment target. … ESG is not that difficult. Whoever says it is difficult, ask them to call me. I can explain.”