Cover Story: Creating your own ESG portfolio

This article first appeared in Wealth, The Edge Malaysia Weekly, on February 28, 2022 - March 06, 2022.
Cover Story: Creating your own ESG portfolio
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Investors in Malaysia who want to create a diverse portfolio of stocks that adhere to environmental, social and governance (ESG) principles are likely to face some roadblocks at the moment.

ESG funds that comprise global and developed-market equities are easy to find. But the same cannot be said for those that hold regional or emerging-market stocks.

When it comes to a purely Malaysian ESG fund, there are only four (excluding wholesale funds) on the Securities Commission Malaysia’s (SC) List of Sustainable and Responsible Investment (SRI) Funds. Of these, two are sukuk funds, one is a bond fund and the fourth is an equity fund. According to industry players, global ESG bond funds or green bond funds are relatively harder to find.

Meanwhile, investing in digital assets has its share of pitfalls. Plenty of studies have pointed out how the mining of cryptocurrencies guzzles huge amounts of energy. Investors may also be concerned about the use of these digital coins in illegal activities and struggle to understand the governance of this decentralised asset class. 

What about investors who want to create a portfolio of ESG stocks themselves? They can rely on the analysis of service providers like MSCI or local brokerage houses, which are increasingly including ESG analysis in their research reports.

Even then, there is no standard method of analysing or reporting on ESG-related information. And analysts may not share the same view on, for example, whether a plantation company is doing enough to prevent illegal deforestation in its supply chain. Also, companies may use different reporting standards, which makes comparison difficult.

This is not to say nothing is being done. There has clearly been a shift towards ESG investing. Two robo-advisers in Malaysia have launched ESG portfolios over the past year. And of the 28 SRI funds on the SC’s list, 18 were launched in 2021.

According to data provider Morningstar, inflows into ESG funds hit a record US$3.9 trillion (RM16.3 trillion) by the third quarter of last year. Full-year inflows into sustainable funds in Malaysia stood at US$263 million, according to Morningstar, which is 1.6% of the Asia ex-Japan universe. 

But according to the financial planners that Wealth spoke to, there is still low demand for ESG investments. 

“Despite the hoo-ha about ESG currently, if you look at the size [of some of the ESG funds in Malaysia], it is still quite small. The demand is not there yet. If you look at the available funds in Malaysia, you will find yourself limited by the options,” says Felix Neoh, director of financial planning firm Finwealth Management Sdn Bhd.

Of the 28 SRI funds on the SC’s list, 18 are global while four cover Asia-Pacific or Asean. Up to 16 are equity funds, five are mixed-asset funds and three are fixed-income funds. Four of the funds did not have their product highlights sheets available online. Most of the SRI wholesale funds feed into global equity funds. 

Investors who want to create their own portfolio of ESG funds will have to do plenty of research themselves. 

“How do you define whether a company is ESG-compliant? This is one of the issues raised by the US Financial Industry Regulatory Authority. There is no standard definition, so how do you do the classification? You can imagine how tedious [the research process] can be,” says Neoh. 

Of course, one can rely on service providers such as Sustainalytics, MSCI or even the FTSE4Good Bursa Malaysia Index as a reference. But even then, the ESG scores for companies may differ between providers. “There are some qualitative aspects that are very difficult to quantify,” Neoh points out. 

Some analysts may give a company high ESG ratings even if it hasn’t achieved a huge reduction in carbon emissions, for instance, because they have confidence in the commitment of the management team. The company is only removed from the investment universe if it has not changed after a predetermined period of time. 

Ultimately, many investors in Malaysia are still focused on returns. “Usually, when I show them the options of funds available [for ESG], they will ask me how I think it will do [in terms of returns],” says Ian Wong, partner at IPP Financial Planning Group, adding that it has been mostly his high-net-worth or fresh graduate clients who are curious about these funds.

“I think ESG is the future, but it’s a bit too early for us to draw any real conclusions now. If a fund only has two years under its belt, I can’t tell how good it is. So, I’ll have to base it on the general [performance] of the fund house and how it is doing against the benchmark.”

The majority of investors that Wong spoke to are taking a wait-and-see approach to ESG, even as many Malaysian companies — particularly those in the plantation, glove and manufacturing sectors — have been hit by sanctions due to allegations of forced labour. “I’m not getting the feeling from people that they link [these events] to ESG,” he says. 

A parallel, however, can be drawn with the shariah investing landscape. The definitions are more developed and it has a bigger investment universe. “When we look at our recommended funds list, we can probably find a shariah equivalent of that fund,” says Wong. 

That is what’s needed for ESG investing to take off. But it will take time, he believes, as companies in developing countries may not have as many resources as those in developed countries to transform.

On a side note, investors who want to have an ESG approach to fixed deposits could look at the financial institution’s financial reports to see who it lends to, says Neoh. Some banks, for instance, have stated that they would not lend to coal mining companies or those engaged in deforestation. 

The burden on investors to do their own research is exacerbated by the risk of greenwashing. The lack of standardised reporting could lead many to call themselves green funds, but without any supporting data. 

According to reports, Morningstar removed sustainability tags from more than 1,200 funds recently because they used “light or ambiguous ESG language”. The good news is that a taxonomy for sustainable finance is being introduced by the EU and other jurisdictions to tackle this form of greenwashing.