Equity investing in China may conjure up images of a momentum-fuelled market. However, developments on the ground show how outdated this stereotype may have become. Attitudes appears to have changed as institutional influence expands in the onshore market and foreign investors increase their exposure. A growing awareness of environmental, social and governance (ESG) issues seems to have followed close behind.
Fidelity was an early mover in the drive to encourage China’s firms absorb ethical factors into their operations. Central to this push is active engagement – talking to boards, developing data disclosure and assisting firms with their communications. To find out more, Catherine Yeung, Investment Director, and Marty Dropkin, Head of Equities, Asia Pacific, sought the views of Flora Wang, Director of Sustainable Investing & Portfolio Manager; Jenn-Hui Tan, Global Head of Stewardship and Sustainable Investing; Eric Zhu, Consumer Staples Analyst; and Binyu Zhao, Sustainable Investing Associate.
The merits of voting power
Fidelity’s analysts and portfolio managers undertake thousands of conversations with management teams each year. At its core, this endeavour seeks to encourage firms to improve their sustainability credentials and establish more ambitious targets. “A good example is our engagement with a leading supplier of dairy products,” says Wang. “We discussed a wide range of ESG issues, including gender diversity, given the company had never had a female director.” Although the business appeared receptive, by the time of its annual shareholder meeting, there were still no women on the board.
“As such, we voted against the re-election of the relevant directors, specifically those on the nomination committee,” she says. A few months later, the company announced a significant overhaul to its board, including its first female director. Although female representation in the workplace has improved over the past decade, the percentage of companies with at least one woman on the board has only risen from 60 to 73 per cent. With gender diversity still at what Wang calls “a very early stage”, this stresses the vital role institutional investors play as they harness voting power to encourage companies to change tack.
Helping firms over the finishing line
Fidelity’s recent ESG Analyst Survey found that confidence in the emissions targets of Chinese companies has doubled over the past year. We believe many firms have increased their efforts, but the challenge they face is effectively disclosing ESG data. “We can help them improve the quality of their ESG-related output and offer suggestions on how other global firms are approaching the issue,” says Zhu. He gives the example of a cosmetics company, which, despite a world-class supply chain and high-quality products, was rated CCC by a third-party rating provider because of the quality of its disclosure. “When I talked to the business, they revealed their work to protect the environment, especially in biodiversity. I suggested they publish the certificates they use and reveal more about their work with supply-chain management,” adds Zhu.
Gathering the strands – consolidating ESG data
“Our biggest influence as an investor is the power to make capital allocation decisions,” says Wang. “Yet for Fidelity to allocate capital, it needs information.” One of the reasons Wang devotes so much time to engagement is that it allows her to assess a company properly. “Disclosure is really about transparency. And transparency helps the market become more efficient,” she continues. Wang also highlights her work with one of China's largest power generation companies. Although the company had disclosed considerable information about its decarbonisation efforts, this was widely spread. Some data featured on the firm’s customer data platform (CDP), while other statistics were embedded in either its annual or ESG reports. “Our recommendation was to consolidate all the information,” says Wang, which it subsequently did.
Breaking new ground with LGFVs
In China, local government financing vehicles (LGFVs), which are investment companies that help build infrastructure projects on behalf of local governments, issued US$28 billion in offshore debt last year and made up one-quarter of China’s 2021 corporate debt fundraising . To date, their engagement with ESG has been limited. “Even listed entities do not currently face any mandatory ESG disclosure requirements, let alone LGFVs,” says Zhao. He mentions recent work with an LGFV on sustainability issues – the first time Fidelity has engaged with this type of investment company. At the initial meeting, he had to explain why a particular ethical topic was considered material before moving on to ask related questions. The fact that the LGFV accepted the meeting was significant as these organisations are generally behind the curve with the quality of their disclosure. “Engagement is often the only way for us to establish greater visibility and find out what is actually happening,” he concludes.
When does divestment enter the conversation?
“Our engagement activities are designed to create value in the companies in which we invest,” says Tan. Divestment, he continues, “should occur when engagement is not working in a way that creates long-term value for our clients.” He also sees exclusion as a good way of expressing an ethical view on markets, but it raises the question of what investors are trying to achieve from ESG objectives. The onus, he says, is on fund managers to show they can positively influence management teams to take steps to enhance the ESG profile of their companies.
“At Fidelity, our 180 globally based equity and fixed income analysts are in the strongest position to make these judgements,” he adds. “They are ideally placed to make decisions about a company’s fundamental characteristics and its sustainability characteristics.”
Sustainable developments ‒ the broader economic picture
It's also worth noting that changes in company mindsets are only part of China's much broader ESG landscape. It is estimated that between US$15 and US$75 trillion will be required to finance the country’s low carbon transition over the next 30 years . From an investment perspective, Tan is paying attention to two sectors “where China is leading both the world and its own targets”.
The first is power generation. Already the largest manufacturer of wind and solar power, China accounted for 35 per cent of all new wind and solar capacity last year and is expected to reach its 2030 target for renewable energy by 2025 on its current trajectory . “It is going to be difficult for other countries to achieve their net zero targets without the renewable infrastructure build out that China will help to facilitate,” he says.
The second is the electric vehicle segment, where penetration has grown from 5 per cent in 2020 to 25 per cent in June this year . “China is one of the world’s largest electric vehicle battery manufacturers and a key supplier of the materials used in those batteries,” he adds. “That will further strengthen its position when the green vehicle transition breaks through globally.”
Sources: 1, 2, 3, 4 - Fidelity International, 2022