Harnessing ESG
Assets owners in Southeast Asia, notably pension and sovereign wealth funds, are increasingly recognising the importance of integrating environmental, social, and governance principles into their investment decisions and strategies.
Last November, Malaysia’s state-owned Employees Provident Fund (EPF) announced plans to have a 100% ESG compliant portfolio by 2030 and a climate neutral portfolio by 2050. It also aims to set up short, medium and long-term decarbonisation targets and create a roadmap on how to achieve these goals.
Malaysian sovereign wealth fund Khazanah Nasional also aims to achieve net zero emissions by 2050.
Their counterparts in the region, including Indonesia and Thailand, have similar plans. The Indonesia Investment Authority, the nation’s sovereign wealth fund, has been actively seeking out ESG-related deals.
In Thailand, the Government Pension Fund (GPF) and the World Bank published a report in March in which the civil service pension fund shares progress and insights on integrating ESG principles into its operations. But the fund has yet to announce long-term goals and targets.
Driving force
With over US$32 billion of assets, the GPF includes ESG factors into decisions pertaining to investments in stocks and bonds as a means to reduce risk.
According to the joint report with the World Bank, the pension fund carries out “comprehensive credit analysis of debt issues with ESG factors forming an integral part of the assessment” in order to select high quality companies in the fixed income space.
“ESG factors are also included in our decisions on initial public offerings and in our external manager selection, appointment and monitoring processes,” it adds.
Adopting ESG principles can also help pension funds build a resilient portfolio. The EPF’s 2022 annual report states that integrating sustainability into the investment process can help achieve better long-term risk-adjusted returns. According to the fund, ESG assets typically generate between 5%- 7% in the long term. “This is in line with our overall approach as a hyper long-term investor.”
As an influential investor, the EPF, Malaysia’s largest pension fund with 1.03 trillion ringgit ($224.22 billion) of assets under management as of end-2023, needs to lead by example for local companies, according to a fund manager at a Malaysian money management firm.
“As the largest investor in the Malaysian capital market, EPF needs to walk the talk and show that it is serious about sustainability. What EPF does on the sustainability front will affect how foreign investors perceive the country,” the fund manager tells Asia Asset Management, speaking on condition of anonymity.
Covid-19
Although the EPF only announced its carbon neutral goals late last year, the fund began integrating ESG across investment strategies in 2020 during the coronavirus pandemic. The impact of Covid-19 on asset values “further confirms the resilience of the ESG investments”.
“At the height of the Covid-19 pandemic, ESG assets deteriorated at a lower rate compared to other assets. For example, public listed companies that embedded ESG elements into their business outperformed their peers in the stock market,” the annual report notes.
Meanwhile, the GPF has established an investment framework with ESG built in to enable it to become a sustainable pension fund. The framework guides the Thai pension fund in seeking investment opportunities that deliver both social and investment returns.
For domestic equity and corporate bond investments, which the fund manages in-house, ESG factors are taken into consideration when analysing and making investment decisions. This is done primarily through a customised valuation approach called GPF-ESG Weight and Score: Asset Valuation Methodology, which uses index provider MSCI data as a starting point for developing ESG scores for companies and industries.
Weighting factors
The GPF has been using the tailored approach since 2018. The pension fund explains that the methodology had to be customised because the MSCI ESG data has limitations in the Thai context. For one, the data is calculated on a global basis, and there are few Thai companies that have comparable scores if the fund were to rely solely on the MSCI weights and scores.
Secondly, the MSCI data does not account for data from local sources. And thirdly, the GPF and the Thai investment community view governance factor as a higher concern than environmental and social factors. Hence, according to the pension fund, it cannot adopt a typical scoring methodology which gives equal weighting to all three factors.
“We have therefore developed a four-step process to modify MSCI’s ESG data and scoring process to integrate Thai-specific data sources, and to reflect the concerns of Thai investors,” the GPF says.
Governance is given a weighing of at least 35%, up to a maximum of 65%, in the customised methodology, with the rest of the weightage going to environmental and social factors to “reflect the significance of governance in the Thai market, yet leaving enough room for E and S issues”.
Stocks and industries are both given a score. An asset with a score of eight and above is defined as low ESG risk. Scores below six fall into the moderate to high-risk category. A score between six and eight is classified as acceptable risk.
“Using these rules, the weighted average cost of capital may be lowered by 25 basis points, resulting in a 4% higher target price. The higher recommended price reflects our belief that a company with excellent ESG performance has a significantly greater upside potential,” the GPF says.
Evolving landscape
Over in Malaysia, the EPF is focusing on developing a stewardship policy that will provide “clear direction” for stewardship responsibilities while taking into account the diverse asset classes and geographies the pension fund invests in, according to the annual report.
“The EPF will also be conducting a baseline measurement of its portfolio emissions level as well as setting its short-, medium- and long-term decarbonisation target and roadmap, which aligns with the EPF’s target of having a climate neutral portfolio by 2050.”
Thailand’s GPF observes that the landscape for responsible and sustainable investing is evolving.
“Globally, we are seeing a rapid increase in the number of policy measures – covering pension fund disclosure requirements, requirements for institutional investors to adopt responsible investment practices, stewardship codes and corporate disclosure requirements.”