Investing with ESG (environmental, social and governance) issues in mind has been growing steadily over the last several years, and China is not immune to the trend. However, one big issue for ESG-focused investors is the quality of the ESG ratings commonly used by major companies like index provider MSCI
In China, this issue is all too clear from recent reports. The author found that MSCI ranked several Chinese companies higher than U.S. companies in ESG—despite issues like their use of slave labor and China’s widespread pollution problems.
HONG KONG, CHINA – JUNE 30: Pedestrians walk by an electronic screen displaying the numbers for the … [+]
In a recent interview with ValueWalk, Zhang Hui of China-based Southern Asset Management highlighted the ESG issues Chinese companies faced. He also provided some insight into the potential opportunities that may be had by investing in the Asian heavyweight today.
Opportunities in the Chinese market
For example, Hui sees the potential for excellent long-term opportunities in the medicine, wine and technology sectors. He also believes consumer staples and liquor are superior to the home appliance sector. Shares of MDI products and cement firms are outperforming coal and iron shares. He also likes cloud computing stocks better than other tech stocks.
Overall, Zhang thinks the liquor and new energy sectors are worth watching over the long term. He explained that they have a stable market landscape and high “vigorousness” and valuations. China is in the process of transforming its energy infrastructure, and he expects significant increases in demand for clean energy like wind and solar power.
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“At present, carbon emissions from energy production account for a high proportion of China’s total carbon emissions,” he pointed out. “In the future, under the guidance of the carbon neutrality target, China’s energy structure will have a significant promotion of green energy.”
The second tier of stocks he is watching includes the medicine and consumer electronics sectors.
“These sectors also have a stable environment, but they are usually undervalued due to their market downturn,” the fund manager explained. “So it is hard to lose even more money. Instead, these stock prices may increase sharply when stimulus policies come out to spur the domestic demands.”
Looking globally, he sees some Chinese enterprises gradually taking leadership in some sectors. He thinks Chinese companies need to be viewed differently for this reason.
Challenges with investing in China
When asked about the challenges associated with investing in China, Hui says enhancing information transparency is a major issue in terms of improving market efficiency. He called attention to Southern Asset Management’s approach to ensuring that what companies do is in line with what they claim to do, especially regarding ESG issues.
Zhang says that the firm digs behind the data and information companies disclose, using big data mining to compare their words with their deeds to ensure that they are true ESG investments. He explained that ESG investments in China are currently used to promote the “sustainable development of human society.”
“Actually, there is a big gap between China’s pension wealth accumulation and future payment for the government due to China’s large population,” Zhang says. “In addition to stimulating individual savings and investment into commercial pension funds to resolve the problems, ESG investments will play an important role to improve the long-term pension investment returns to moderate this gap.”
China’s focus on ESG
Zhang, who manages the China Southern ESG Theme Equity Fund, said Chinese companies pay more attention to the environment and social governance elements of ESG. China announced its intention of hitting peak emissions by 203 and achieving carbon neutrality by 2060.
The nation has recently started to regulate greenhouse gas emissions by issuing ESG-related policies. Greenhouse gas emissions are relatively easy to measure and quantify for ESG ratings, so Chinese companies are especially concerned about them.
“In addition, corporate governance is very important for the sustainable development of companies,” he added. “For example, governance structure and executive management need to be considered for investors. The ratio of males and females on the board also got wide attention these years. The diversity of the board could provide more diversified suggestions to help companies make appropriate decisions.”
Southern Asset Management looks for three things in its traditional investments: good industry, good company and good price. For Zhang’s ESG fund, he also considers all three components of ESG, turning the firm’s “three goods” into “six goods.”
Macro and geopolitical impacts on China
Absolute return funds are the ones determining this year’s market trends. He sees valuation as the most important indicator for this fund strategy.
Zhang’s investment philosophy over the last three years has been based on company performance and industry boom. However, he admits that while it may be applicable over the long term, it might not be effective in the short term.
At the fundamental level and factoring in the pandemic and increasing raw material and transportation costs, Zhang expects the earnings forecasts of publicly traded companies to be revised downward. As a result, he believes only low valuations can create protection. However, he will still do further study in search of companies that can deliver growth despite the unfavorable environment.
“At the operational level, we will try to identify logical underlying stocks among companies with relatively cheap valuations and hopefully sell the varieties with high valuations and less solid fundamentals in the rebound so as to dynamically adjust the portfolio’s risk-return ratio,” Zhang adds.
Why it’s harder to find good stocks this year
Southern Asset Management’s stock selection criteria include the competitive landscape first, followed by industry boom and valuation. The strategy might not be effective in specific markets, but it should work on a long-term basis because it covers many more markets.
He added that the excess liquidity model states that the stock market risk is expected to remain relatively low until the economy stabilizes. This is especially true of low-valuation and outperforming small-cap stocks because they are inherently unaffected by U.S. debt and negative policies.
However, he also said that it’s far more difficult this year than last year to find large-cap stocks with very low valuations or small-cap stocks with better-than-expected fundamentals due to last year’s significant outperformance.
“My personal strategy is to seize the opportunity of outperforming growth stocks during the performance-intensive period and then switch appropriately to pro-cyclical sectors after the valuation rebound,” Zhang explains.
What Zhang sees now
Based on the current environment, Zhang expects “marginal improvement” of real estate, infrastructure and other industry policies before the economy stabilizes. He believes this dynamic could offer opportunities in real estate and upstream cyclical products. he also expects demand for certain consumer goods to pick up.
He also pointed out that there have been no outperformance similar to semiconductors in 2019 and new energy vehicles in 2021. Both sectors enjoyed explosive growth in demand, paired with performance growth from scratch, regardless of valuation.
Zhang believes that industries like new energy still enjoy an excellent growth attribute, but he expects their fundamentals to polarize. Additionally, he expects U.S. Treasury yields to remain high and the gains of each industry to be restrained by valuations.
“The ‘value for money’ investment may prevail throughout the year until new growth industries appear,” Zhang concludes.
Michelle Jones contributed to this report.
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