Countdown to Climate Finance Week: Q&A with Krane Advisors an ESG ETF28 October 2020
Vanora Madigan, Director of DMS speaks to Dr. Xiaolin Chen Head of International KraneShares about integration of sustainability, considerations , driving factors and the future of ESG ETF investing.
As part of Krane’s integration of sustainability into the investment framework what factors are considered?
Environmental, Social, Governance (ESG) investing is growing in popularity. With ESG scoring methodologies now widely established by reputable companies like leading global index provider, MSCI, investors can utilize ETFs and index funds to systemize their decision-making process through an ESG lens. However, the resulting impact on returns generated from ESG criteria application can vary significantly between markets. This dispersion is particularly evident when comparing the difference between standard and ESG index returns in the US and China. In the US, a comparison of the MSCI USA and MSCI USA ESG indexes shows that ESG harmed performance with the former returning 140% and the latter 130% since 2013. The 10% underperformance over a seven-year timeframe of the US ESG index may be tolerable for investors who accept trading off performance for the positive social benefits of ESG. Still, in China, a different story is unfolding.
Below is a chart that shows the outperformance of the MSCI China ESG Leaders Index relative to the MSCI China Index 1. Since the inception of the ESG index through 9/30/2020, the MSCI China ESG index returned 170%, while the MSCI China Index returned 102%, representing an outperformance of 69% for the ESG index over the broad China market. It is important to note that the ESG criteria MSCI uses for its China ESG index are the same criteria MSCI uses in the US and other global markets. MSCI's ESG criteria have had a significant performance-boosting effect in China that did not occur in the US.
ESG investing is inherently future-looking. There is perhaps no place more meticulously focused on planning for the future than China. Every five years, the nation issues its Five-Year Plan, where the government outlines its vision for the future. Capping carbon emissions, expanding green energy output, and developing high-tech sectors are fundamental to China's long-term plans.
China's economic and technological transformation drives the demand for a more educated workforce. In recent years, many Chinese companies in knowledge-intensive sectors have improved their talent programs, which has upgraded their MSCI ESG rating. Within MSCI's ESG Rating under its Social Pillar, companies with healthy human capital development, labor management, and employee benefits programs receive higher rankings resulting in large index weightings to companies within the internet/technology and healthcare sectors in China.
Looking at Internet/technology companies within the MSCI China ESG Leaders 10/40 index, Meituan Dianping is up +164%, Tencent is up +50%, and Alibaba is up +44% year-to-date 2. Wuxi Biologics is up 126% this year within the healthcare sector, driven by the COVID-19 pandemic, which has boosted companies committed to drug and vaccine development within this sector.
Looking specifically at Chinese companies that achieve high scores for their carbon emissions and product carbon footprint reduction within MSCI's Environmental Pillar, China's electric vehicle (EV) manufacturers are notable standouts. Nio Inc-- known as the Tesla of China, is up 580%, and BYD Co. is up 275% year-to-date. In 2019, China accounted for nearly 50% of all-electric vehicles sold worldwid 3, and by 2025, EVs are projected to account for 25% of China's new car sales4.
What considerations did Krane choose in setting up funds in Ireland, and was sustainability factored in?
We have had a positive engagement with the Central Bank of Ireland (CBI). The CBI’s clear guidance and communication throughout the approval process makes the process of launching new ETFs straightforward. The ETF industry in Ireland is well developed with a comprehensive ecosystem of service providers covering every area an ETF Issuer needs to expand their business throughout Europe.
Ireland is an ideal location in that it offers broad exposure to European investors. Concerning sustainably responsible investing, we have noticed that European investors showed an early interest in and have been faster at adopting ESG investment practices than investors elsewhere in the world.
Who do you see as driving the demand for more sustainable investment, and does this differ geographically?
At Krane, there has been strong institutional demand. The trend of progressive institutions looking to tailor their investments to their core values is a global phenomenon. We are also seeing strong demand from international retail investors. Many of these investors are interested in gaining access to China's strong EV stocks. Some individual investors have difficulty accessing these stocks because they are predominantly listed in Hong Kong, Shanghai, and Shenzhen stock exchanges. Our funds can act as access vehicles for these stocks.
Global demand for sustainably focused investments has become more widespread because ESG scoring is much more accessible. Additionally, there has been an influx of new funds over the past few years, which provides investors with a growing number of options. Specific markets, such as China, also lend themselves particularly well to ESG filtering for preferable sector exposure and potentially better returns.
What do you expect the future holds for those interested in ESG ETF investing?
We believe ESG investing will not merely be limited to a niche investment strategy but instead be factored into an investors' overall due diligence process. The transparency, liquidity, and expanding diversity of the ETF universe in Europe makes ETFs an ideal vehicle for investors to efficiently implement ESG strategies.
Looking to the future, ESG scoring may have started as a tool designed for investors who wanted to make a positive social impact or mitigate climate change risk on their portfolios. However, beyond aligning with investors' values, these ratings prove to serve, at least in China, as an invaluable filter for identifying high-quality growth stocks. As other major economies worldwide begin to make the concerted shift away from fossil fuels toward green infrastructure, we anticipate ESG criteria applied to other markets will provide similar demonstrable performance benefits as it does in China.
1MSCI China ESG Leaders Hybrid Index: The hybrid Index is comprised of the parent index, MSCI China ESG Leaders Index, from Jul. 12, 2013 to Nov. 7, 2019 and the MSCI China ESG Leaders 10/40 Index going forward. The parent index is used prior to the MSCI China ESG Leaders 10/40 Index's inception to show long-term historical performance.
2Note: year-to-date company performance as of 10/22/2020.
3 International Energy Agency. “Global EV Outlook 2020”.
4Reuters, “China wants new energy vehicle sales in 2025 to be 25% of all car sales”, 12/2/2019.
Climate Finance Week 2020 will be taking place 2-6 November. Find out more information at www.climatefinanceweek2020.ie about the series of virtual events that will be taking place.
Dr. Xiaolin Chen Head of International KraneShares
Xiaolin is a Managing Director, Head of International of KraneShares based out of the United Kingdom. Xiaolin oversees investment solutions and strategy effort and manages the firm’s business outside of the United States.
Prior to joining the firm, Xiaolin was a lead portfolio manager with J.P.Morgan Private Bank managing fund of fund portfolios comprising public market and liquid alternative assets. Xiaolin was responsible for client portfolios totaling $70billion collectively across a range of different risk parameters. Her duties included development of investment strategy, tactical asset allocation and investment implementation. Xiaolin has extensive experience in both London and New York developing and managing investment solutions to help clients meet a wide range of investment targets and objectives. She has covered clients across EMEA, Asia and the Unites States and has in depth onshore and offshore multi-asset investment solution knowledge. Xiaolin holds a Bachelor’s Degree and Ph.D. in Computer Science, both obtained from the University of Nottingham, the United Kingdom.
Vanora Madigan, Director, DMS
As a Director within the relationship management team of DMS Investment Management Services (Europe) Limited, Vanora provides corporate governance advice and leads with the design and implementation of internal controls and operating procedures associated with regulated investment funds.
Vanora has extensive experience in UCITS, AIFMD, and alternative investment vehicles and brings with her a background in legal investment and client relationship management with over six years spent at Fidelity Worldwide Investment in Dublin, servicing corporates, banks, pension funds and financial institutions. She previously served as a stockbroker with Cantor Fitzgerald and as an FCA regulated advisor at Lehman Brothers and with UBS Private Banking in London.