A world away from the bustle of Shanghai, another major growth initiative for asset managers has been to reorient themselves around sustainable investing, specifically environmental, social, and governance parameters, as opposed to being solely oriented toward maximizing investment returns. The business case is straightforward: ESG taps into investors' very real concerns about sustainability, while at the same time the lack of consistent standards and metrics defining ESG prevents low-cost passive ESG options from emerging. The result is that ESG can breathe new life into legacy active strategies, enabling managers to charge a premium for an attribute (ESG) that is not tied to investment returns (at least not near-term returns). In our analysis of U.S. mutual funds, the average asset-weighted management fee for "sustainable" funds was 51 basis points, compared with 38 basis points for the broader universe of active mutual funds. ESG commanded a 34% premium. Looking beyond fees and beyond the U.S., in Europe, ESG has become a non-negotiable investment criterion. European regulations and evolving investor preferences mean ESG is here to stay, and sustainable investing in general is fast becoming simply "investing." To not incorporate sustainable criteria in an investment process will soon be considered negligence.
These two seemingly distinct opportunities — China and ESG — are linked by the business risk posed to managers that pursue both initiatives in a siloed fashion. In their home markets, managers risk being called out for greenwashing: making claims about ESG that are inconsistent with their funds' investments in certain Chinese assets. Meanwhile the risk to managers' Chinese businesses comes from ESG-related statements, activism and investment decisions at home, which may reverberate in a spectacular fashion in China should they run afoul of Chinese anti-sanctions regulations or anger Chinese public opinion.
Managers' investment decisions (such as divestment) or public statements in their home markets that touch on China's internal affairs or matters of sovereignty are subject to the recent anti-sanctions law. Any Chinese national, not just official bodies, can bring charges, and rulings are not open to judicial appeal. The consequences for international managers' Chinese subsidiaries could include serious disruption to their local business.
It doesn't have to be this way. Managers can simultaneously embrace ESG and China and in ways where each initiative reinforces the other.
- Start by breaking internal silos: Asset managers have relied on distinct teams to lead their ESG efforts and their Chinese business activities. Today, these distinct teams rarely if ever interact and this needs to change.
- Define a China business strategy and operating model: Establish how China — both the domestic market as well as home-market demand for Chinese assets — fits into an asset manager's long-term growth agenda. Map out how the firm's global operating model will evolve in order to successfully incorporate a local subsidiary, if that approach is required.
- Implement an enterprisewide ESG approach where sustainability is not relegated to a silo but is instead incorporated across all investment teams as well as asset managers' own operations: this is a best practice even without any Chinese ambitions. A lack of external ESG standards shouldn't be a free pass for inconsistent approaches internally.
- Finally, determine how the ESG approach fits with the intended global operating model (especially for China). By design, the ESG approach can focus on where it can have a productive impact. And it should include an element of coordination across geographies to avoid decisions in one region from harming other parts of the business.
- A thoughtful and deliberate approach to ESG that incorporates China can serve as a catalyst for growth. China has ambitious environmental and decarbonization goals. It has the largest installed generating capacity of solar power of any country and has the largest fleet of electric vehicles in the world. Rather than introducing risks, asset managers can establish a virtuous cycle by deliberately linking activities in China with the right ESG approach.
Daniel Celeghin is a managing partner at Indefi, an asset management strategy consultant, based in New York. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.