New research from Willis Towers Watson outlines importance of balancing ESG-related risks and opportunities when investing in China

Willis Towers Watson, a specialist global advisory, broking and solutions company, has released two research papers that outline how institutional investors can allocate capital to China, while managing environment, social and governance (ESG)-related risks and exploring ESG-driven opportunities. 

Research shows that although Chinese capital markets provide diversification benefits and attractive alpha opportunities for global investors, substantial challenges on the sustainable investment (SI) front have made investors cautious at the same time.  

The Willis Towers Watson (WTW) study shows that by using a total portfolio approach and active management of Chinese assets, investors can gain the long-term diversification and expected return benefits from adding the Chinese assets without a negative impact on their overall sustainability profile. 

“Sustainable investing is not just about properly integrating ESG-related information for risk management purposes. It is also about recognising that long-term ESG-related themes, such as climate change, can create return opportunities. China has in recent years emerged as a world leader in funding and developing technologies to combat climate change and its net-zero pledge will greatly influence economic and climate policies in the decades to come,” says Liang Yin, Director in WTW’s Investments research team and China project lead.  

“Moving forward, we expect China to be a major source of climate change driven investment opportunities.” 

Evidence shows that over the last few years China’s SI development has gathered significant positive ‘ESG momentum’, which can be a financially significant indicator of strong future returns. The total portfolio approach considers each risk factor in aggregate across the whole portfolio rather than just within each asset class. This framework allows investors to reduce exposure to assets that have negative sustainability characteristics elsewhere in the portfolio and increase allocation to Chinese assets that have better ESG momentum and better overall risk and return potential.  

Alternatively, increasing exposure to assets that have positive sustainability characteristics, for example investments in climate solutions, can be used to balance the overall sustainability profile. In addition, skilled active management can significantly reduce risk exposures related to poor ESG practices that sometimes can be encountered in China. When selecting investment managers, there needs to be a strong emphasis on their ESG integration and stewardship practices.  

“We strongly believe that skilled active management should be front and center of any institutional implementation solutions to access China. Given the current state of China’s SI development, we do not recommend a blanket allocation across Chinese assets,” says Paul Colwell, Head of Advisory Portfolio Group, Investments Asia, WTW.  

“Accessing China’s large and rich opportunity while navigating its complex SI landscape can pose a significant governance challenge for many asset owners. However, the benefit of doing so outweighs the risk and incremental costs. Asset owners do not necessarily have to have a presence in China or internal staff who can speak Chinese, but they do need to have well-resourced local partners on whom they can lean when making allocation decisions and selecting managers,” adds Yin. 

Scenario analysis by WTW suggests that Chinese assets may build up to 20 per cent of global investor growth portfolios over the next 10 years. Despite recent progress made by policymakers in opening up China’s domestic capital markets, the average institutional allocation to China remains at a low level of around 5 per cent (of the growth portfolios). China presents a strong investment case but building exposure to China should be a journey that balances the pace of market improvements with the imperative to achieve diversity in a global portfolio. The research, ‘China through a sustainable investment lens’ is published in two papers: ‘Part 1: The case for including China in a sustainability focused portfolio’ and ‘Part 2: Incorporating ESG in portfolio design and implementation considerations’.