Asia is becoming a vital market for those looking to drive sustainable change. With appropriate research and an understanding of local issues, find out how ethically focused managers are working with the region’s companies to enhance their environmental, social and governance (ESG) profiles and increase the potential for long-term returns.

Sustainable investing (SI) in Asia is still at an early stage, but this may create opportunities given the large universe of firms that could benefit from improved ethical credentials. It’s true that challenges remain. For one, the quality of ESG reporting varies significantly across the region, with only a few countries introducing mandatory disclosure laws – China being one with its 2008 Environmental Information Disclosure Act. Coupled with this are less stringent regulations on ethical company practices. Also, whenever a new concept emerges, such as SI, bubbles may form. Therefore, asset managers need to focus closely on valuation measures to ensure a company’s share price accurately reflects the strength of its underlying fundamentals.

Asset managers are driving sustainable improvements
In practice though, asset managers are looking through these challenges. They aren’t waiting for new laws to be passed or taking third-party ESG data as gospel. Instead, they’re grasping the initiative and engaging with firms with the potential to improve their ESG profiles. As a result, more companies are prioritising sustainability issues. This is key because businesses with better disclosure, more robust processes, and a greater alignment with ethical metrics tend to be in a better position to grow over the longer term.

A two-pillared approach to company research
Until recently, SI analysis fused fundamental bottom-up research with third-party data. A business was then judged to be either ‘good’ or ‘bad’. But this process of elimination did little to alter a company’s behaviour because management teams were often not conscious of the fact that their firm’s stock had been excluded due to ESG concerns. So, for many of these corporates, it was business as usual.

However, this simplistic approach is being disrupted, and SI research is now viewed as a two-pillared endeavour. Asset managers are still performing fundamental stock research that considers third-party data, but it is being blended with an assessment of the non-financial impacts of a company’s activities. This so-called double materiality paints a far better picture of a firm’s ethical mindset.

Becoming a partner as well as an investor
Company engagement is critical to double materiality. Asset managers increasingly see themselves as catalysts for positive change by partnering with companies, making them aware of how they can improve their sustainability profiles. In the past, a good number of these businesses would have been excluded from an investment portfolio, which now appears unfair given many of them genuinely want to make the green transition.

Engagement also helps put a company on notice. If it doesn’t improve on key parameters within a specific timeframe then managers may sell the holding.

Thorough research uncovers attractive investment opportunities
For investors, a hugely valuable by-product of double materiality is that asset managers are gaining a more profound understanding of thematic developments in the region. Examples include the technology sector, where semiconductors have a long-term value proposition. Engaging with individual companies has made it clear that the semiconductor industry has been consolidating over the past ten years, which should result in a more rational, less volatile operating environment. Fewer players also mean higher costs of entry that should protect the value of these businesses.

In the financials segment, many high-quality companies, especially in less developed markets, have the potential to outperform as the region recovers from the pandemic. Insurance companies, too, are showing great potential.

Elsewhere, some healthcare names could become global players, especially those in the biologics space or firms that specialise in producing innovative therapies. Again, by performing deep analysis, asset managers are identifying corporates with outstanding execution strategies that should enhance their value.

Lastly, a theme tied closely to ESG thinking is green technology. A solid example is the electric vehicle (EV) sector, where the research process is taking analysts beyond the car manufacturers and into the EV supply chain. Here, they find appealing businesses that supply a broad range of components, such as battery specialists and the developers of in-vehicle technology.

Therefore, given its ability to identify ethically conscious companies and provide valuable insights into thematic developments, two-pillared SI research should become integral across the entire asset management industry and underpin the return profiles of investors’ portfolios.

Originally published by Fidelity International investment experts