Asian investors dial back ESG efforts but sustainability goals endure
Sustainability-minded members of the investment community might well be concerned by the slowing pace of environmental, social and governance (ESG) activity among Asian institutional investors this year — but the authors of a recent survey remain optimistic.
The Asia Funds ESG Survey 2023, conducted by international law firm Morrison Foerster, in which 100 Asia-headquartered $1-billion-plus AUM fund general partners participated, found that amid an overall slowdown in ESG activity, fewer than one in four had pulled out of an investment process after discovering ESG problems during due diligence.
Morrison Foerster
According to Marcia Ellis, a Hong Kong-based partner and global co-chair of the private equity practice at Morrison Foerster and a co-author of the report, this wasn’t evidence of investors shrugging it off and accepting the shortcomings, but a sign of their determination to address them and an indicator of increased potential for returns.
“The question is whether any remedy to the ESG problems will destroy the profit of the portfolio company, or whether it’s something you can figure out a way to solve and, by doing so, increase the portfolio company’s value for you as an investor,” she told AsianInvestor. “A lot of private equity funds don’t mind at all if there’s a problem, because they can take it to the negotiating table and reduce the price of the target.”
EMBRACING IMPROVEMENT
Desmond Foo, an investment director at the Singapore branch of US-headquartered multi-family office Leo Wealth, told AsianInvestor that some investors used ESG considerations as a filter in order to exclude assets such as fossil fuels from their portfolios, but that his preferred strategy was to “embrace” such investments, so long as their ESG profiles showed material improvement.
“My way is a scoring system, meaning that out of a possible 100, an oil company, for example, could score 50 — which doesn’t exactly scream ‘green!’ – but, say, six months ago, it could have been just 35, so that could show the company is implementing strategies to improve its sustainability,” he explained.
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Morrison Foerster
Per Lindberg, a Singapore-based partner at Morrison Foerster and another co-author of the report, told AsianInvestor that even though the regulatory impetus to comply with ESG standards was generally less forceful in Asia than in the European Union and the United States, investors were coming under increased pressure to ensure that portfolio companies with business links to those jurisdictions were compliant with their regulation.
ALSO READ: Asian private equity firms grapple with tougher ESG demands
“Institutional investors are using those standards in their diligence,” he said. “What’s driving that? Well, look at the EU Corporate Sustainability Due Diligence Directive, which, once adopted, will require in-scope companies to undertake due diligence on ESG issues such as human rights abuses and environmental harm. So long as you have that nexus with the EU or the US, as an investor, you’re really going to have to start turning over those stones to see what’s underneath, and you may not have a choice but to turn down an investment or ensure that any concerns are addressed before you invest.”
LOOKING FOR TROUBLE
Perhaps counterintuitively, Morrison Foerster’s report suggests that sustainability problems are increasingly a draw for many investors, with 91% of respondents having invested in companies with negative or neutral sustainability credentials in the belief that addressing these issues would drive improved valuations, up from 82% in the same survey the previous year.
Nevertheless, the slowdown in ESG activity, manifested among the 90% of survey respondents that had made no recent changes to their ESG policies or worked on implementing those policies during the past year, remained a key finding of the survey.
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Ellis and Foo attributed the sluggish pace of activity to macroeconomic conditions — in particular, the effect of persistent high interest rates.
“It doesn’t mean that people are losing interest in ESG,” Foo said. “It’s just a function of where we are in the current macro investing environment. Case in point this year: renewable energy companies have performed quite poorly as rising inflation has driven up input costs and compressed margins, and tightening credit conditions have made it difficult for some companies to refinance, putting pressure on bottom lines and stock prices.”
Jeremy Lim, co-founder and chief operating officer at Grandway Family Office, a Singapore-based multi-family office, told AsianInvestor: “Today if I put my money into US Treasury bonds, I can get 5.25%. If I put my money into an ESG fund, I’m getting 4%. Pick your bet.”
Ellis said the timing of previous ESG initiatives was another factor behind the slowdown.
“It’s really in the last three years that Asia-headquartered PE funds have adopted extensive ESG policies,” she said. “If you adopted your policy only two or three years ago, you’ve gotten to the stage right now where you’re trying to implement that policy. You’re not quite ready to make changes or adopt additional policies.”
According to Morrison Foerster’s survey, 50% of respondents had held back on ESG activity due to concerns raised by limited partners or by principals and investment professionals.
HOLDING BACK
Given that LPs typically demanded higher ESG standards, Ellis said, the 24% that had felt pressure from LPs had likely found their data questioned.
“The LPs are saying, ‘Ok, how have you gotten these statistics, and how do you derive your data?’,” she said. “So they’ve sent GPs back to the drawing board a little bit to figure out how they’re going to get good enough data so certain policy thresholds can be met. I don’t think LPs have been saying simply, ‘Don’t do it’.”
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Lim said that in the role he held until three months ago as chief investment officer at a Singapore single-family office, he had felt let down by ESG data that fund managers had presented to him.
“We turned down a lot of ESG funds because of their managers who weren’t very confident with the numbers we were seeing in our due diligence processes,” he said. “We cannot trust people that don’t understand the macro environment they’re operating in and who see only what they want to see.”
Ellis said the remaining 26% of survey respondents that had held back on ESG amid concerns raised by principals and investment professionals had likely been put off by cost pressures.
“In this uncertain economic environment, you have to justify every spend — not just ESG spend, but everything,” she said.
However, in a further sign that ESG priorities remained robust, a Bloomberg Intelligence global survey of 250 C-suite executives released in November found that 55% of respondents saw ESG as one of their top two priorities.
“There’s only one way to read that,” Ellis said. “We’re talking about two priorities. Your top priority has to be to make your company more valuable, to increase your share price. There’s only one other slot available – ESG’s got that slot.”