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Green fund fever grips China. But is it sustainable?

Chinese asset managers have started launching sustainable labeled funds like there’s no tomorrow. Could a green investment bubble be building in the world's highest emitting country?

Fortunately, China wasn’t infected by just the Covid virus in 2020. It also received a decent dose of green fever. 

Following the surprising announcement from President Xi Jinping in September 2020, where he vowed that China would become carbon neutral by 2060, Chinese asset managers have started launching sustainable labeled funds like there’s no tomorrow. This is very similar to the corporate world, where we have been bombarded by pledges around carbon neutrality or net-zero promises.

For now, the first movers in this space are enjoying a significant advantage with China’s first photovoltaic industry exchange-traded fund (ETF) increasing its assets under management by six times in December 2020 alone to 10 billion yuan ($1.55 billion). A plethora of new energy green funds are also in the pipeline.

These new players will bring more assets into an already very hot sector. China’s new energy index doubled last year, pushing up the sector’s earnings multiples to almost 90x. Fairly steep compared to the wider Chinese market which trades at around 22x. Perhaps the sector’s prospects are bright, but the valuations are less so. The recent unprecedented inflows and the limited number of green energy companies has caused the stock prices to rise rapidly, now fueling fear of a bubble.  

ESG integration must not compromise returns. We all want to do better. But we also want to become richer.

So is this really sustainable? There is an interesting divergence between the stock market and the real Chinese economy, which still relies almost 60 per cent on coal. Not to mention the newly commissioned coal plants (17 projects received permits in the first half of 2020) that will make emissions goals harder to achieve, and stock valuations harder to justify.

What do we say?

As we published in a recent article, over the past year we have witnessed an unprecedented rise in the number of ESG funds. However, many have failed to scale. Maybe China is not the only one experiencing green fever!  

The supply of ESG funds has grown globally, driven by higher demand for sustainable products, improved ESG data availability and more evidence around the financial materiality of sustainability factors.  

What about the asset under management? Sample data suggests that 57 per cent of the ESG funds have assets under management of less than $100 million and around 73 per cent have less than $250 million. In fact, only 0.9 per cent of the ESG funds have more than $5 billion. 

Lots of funds doesn’t seem to equal lots of assets. Why is this the case? We have identified four key drivers behind this fragmentation. First, many ESG funds don’t have a long track record. In China for example, many asset managers are just getting started after Xi’s recent announcement.

Second, there is the chicken and the egg problem. Some funds remain small because they are currently small. Third, many players in the ESG space are newcomers and cannot benefit from a well established brand name. This makes investors more suspicious and it takes more time to earn their trust.

Finally, there is the issue around performance. ESG integration must not compromise returns. We all want to do better.  But we also want to become richer.

What does it mean?

China has joined the net-zero race – the show is on, but the road ahead is very steep. We appreciate and understand the enthusiasm around this unexpected announcement, but important actions must be taken by the highest globally emitting country, if it wants to achieve its ambitious target. China has to come up with an aggressive (and necessary) plan to transition away from its reliance on non-renewable energy sources, lack of energy efficiency, and rapidly growing energy demand.

On a more positive note, let’s remember that China has been a hub for innovation for years. It is already a leader in battery cell technology, for example, and if it plays its cards smartly, it can position itself as a technology provider for decarbonisation around the world.

So let’s hope that this green fever becomes a permanent condition.

This article was written by asset management firm Arabesque

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