(Bloomberg) — The top-performing ESG fund for emerging markets surpassed its peers in the first half of 2022 by adopting a low-risk strategy that rejected tech companies Tencent Holdings Ltd., Alibaba Group Holding Ltd.
and Taiwan Semiconductor Manufacturing Co. Ltd.
The Robeco QI Emerging Conservative Equities fund declined 4.9% this year, while the 15 largest actively managed ESG-labeled emerging market equity funds plunged about 23% on average, according to data compiled by Bloomberg.
Top holdings in Robeco’s $2.2 billion fund are Samsung Electronics Co.
Ltd., Infosys Ltd. and Bank of China Ltd. By comparison, TSMC ranks as the largest investment for all of the other biggest ESG emerging markets funds, which also have sizable stakes in Tencent and Alibaba.
Shares of TSMC, Tencent and Alibaba have fallen as much as 26% this year amid rising global concerns about inflation and slowing economies.
Tech and financials are the biggest holdings in all of the biggest 15 funds, which also focus on four countries — China, Taiwan, South Korea and India.
The funds largely avoid markets in Latin America, Africa and other emerging regions. This bias can divert greener capital that poorer countries need to decarbonize their economies and raise living standards.
Currently, 80% of global financial assets are in developed countries and 88% of sustainable investment funds are focused on global or developed markets.
By contrast, 70% of the required United Nations Sustainable Development Goals and Paris Agreement capital needs to be directed towards developing countries, according to a May survey by South African asset manager Ninety One Plc.
Rotterdam-based Robeco said its fund’s success reflects a strategy of hand-picking stocks that are considered low risk and perform well over longer time horizons, and a willingness to deviate from its benchmark — the MSCI Emerging Markets Index — by as much as 10%.
“In the recent market turbulence, the low-risk characteristics of the stocks we select have helped a lot in terms of returns relative to the benchmark and to peers,” said Arnoud Klep, portfolio manager in Robeco’s quantitative equities team.
Tencent and Alibaba didn’t make the cut as they featured low on Robeco’s stock ranking. “TSMC does well on sustainability characteristics — it’s low on carbon and environmental footprint, and most ESG rating firms assign it a strong rating — but if you also take into account low risk and other characteristics, we find better candidates,” Klep said in an interview.
Most ESG-focused emerging market funds tend to be overweight tech, financials and consumer goods because companies in these sectors typically have stronger finances, said Dan Kemp, the London-based chief investment officer of Morningstar Investment Management.
This has been a winning strategy for most of the past 30 years, he added.
But that approach has backfired for some this year. Fidelity’s $4 billion Emerging Markets Fund is the worst performing of the biggest ESG-labeled emerging market funds, falling 33%, followed by the Goldman Sachs Emerging Markets Equity Fund, which dropped 28% as of Thursday, Bloomberg data show.
The two funds each have more than 14% of their assets in TSMC, Alibaba and Tencent.
The Robeco fund earns its ESG credentials because it adheres to Article 8 of the EU’s Sustainable Finance Disclosure Regulation.
It excludes companies that derive revenue above a certain threshold from controversial weapons, tobacco, palm oil, coal and oil sands, according to its prospectus. It also has a lower environmental footprint than its reference index, tilts towards companies with better than average ESG scores, and adopts a voting and active engagement policy.
Unusually, even though it meets the SFDR requirement, Robeco doesn’t advertise the ESG theme in the fund’s name.
That reflects some asset managers’ growing hesitation to slap an ESG label on a financial product and thereby invite concerns about greenwashing.
The SFDR’s main goal is to stem inflated ESG claims, but it doesn’t make the job easy.
It defines Article 8 as “light green” investments only in vague terms, giving fund managers considerable leeway in deciding what’s ESG and what’s not. In February, for example, data provider Morningstar Inc. removed the ESG tag from more than 1,200 funds that it said failed to fulfil the promised environmental, social or governance goals.
Most of the axed funds were Article 8.
Robeco’s emerging market fund has its share of controversial ESG stocks, including carbon-intensive companies China Petroleum & Chemical Corporation (Sinopec) and PetroChina, each representing around 1% of the fund’s total net assets. Klep justifies their inclusion on the basis of a three-year plan in place to actively encourage Sinopec and PetroChina to boost their sustainability performance.
If that engagement works, Robeco says it will return to a full 2% equity position in each of the companies. If not, it will likely divest.
Indeed, Robeco may yet rename the fund to better reflect its ESG stance.
“The investment industry is still looking to digest the impact of SFDR and how it impacts the investor landscape,” said Klep. “We’ll see how it evolves.”
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