Organisation: UBS SDIC Fund Management Company
HQ country: China
Signatory type: Investment manager
COVERED IN THIS CASE STUDY
Asset class: Listed equity
UBS SDIC Fund Management Company (UBS SDIC) was established in June 2005. It is the first joint venture fund management company in China, of which SDIC Taikang Trust owns 51% and UBS owns 49%.
The Chinese government runs a Qualified Domestic Institutional Investor (QDII) programme. The quota scheme allows qualifying Chinese institutional investors to invest in foreign assets. Given the longer track record of sustainable investments in developed markets, UBS SDIC takes the view that the QDII programme not only allows Chinese investors to access foreign assets, but also provides asset managers with the opportunity to develop their approaches to ESG incorporation.
Amid efforts to begin integrating ESG factors across domestic portfolios, UBS SDIC is capitalising on the experience of the QDII programme by developing the following areas:
- Embedding ESG considerations into domestic portfolios through materiality matrix analysis in fundamental valuations.
- Carrying out top-down research of investment opportunities derived from the Sustainable Development Goals (SDGs) in China.
- Bridging the gap between emerging markets and developed markets in active ownership and ESG integration standards.
Why this approach?
UBS SDIC decided to develop its responsible investment approach based on the following rationales.
First, the current assets under management (AuM) of QDII programmes is around US$34bn. According to our in-house study of 356 QDII strategies, the vast majority are not yet integrating ESG factors into investment decisions. This is despite the fact that most QDII strategies have considerable exposure to developed markets, where ESG factors play important roles in determining investment decisions. Therefore, UBS SDIC sees ESG integration in QDII strategies as part of its responsibility to its clients and to delivering on mandates.
Second, the QDII quotas totalled US$154bn and were granted to 174 financial institutions by the end of May 2022. The potential size of inflows and the number of investors could make an impact on the global sustainable investment market. UBS SDIC shares its learnings from its QDII investments with peer institutions that might lack ESG integration experience or expertise.
Finally, the taxonomies of sustainable activities currently available in developed markets are important references for sustainable investors in emerging markets. Pure bottom-up strategies may lead to fragmented definitions of sustainable investments.
At UBS SDIC, experience of ESG incorporation gained from the QDII programme can facilitate the integration of ESG factors into equity valuations by domestic sector analysts and portfolio managers. Furthermore, the bilateral relationship developed between emerging market and developed market asset managers as part of the QDII programme can contribute to the creation of a localised SDGs-aligned investment framework.
The approach in practice
The approach consists of two phases:
The current QDII quotas granted to UBS SDIC are about US$2bn. Senior management at UBS SDIC has considered sustainability as a top priority for QDII portfolios that are in the pipeline. From the perspective of asset allocation into foreign assets, the objective is to deliver returns from sustainable investments in the health care sector or other global equities with SDG themes. This year, two experienced investment managers have been appointed to manage sustainability-focused QDII strategies.
UBS SDIC aims to leverage the ESG integration approach taken for QDII strategies for domestic portfolios, which have approximately US$30bn in assets. To further this aim, a taskforce including executives and investment heads was set up last year. The ESG taskforce oversees the integration progress and holds research meetings on a biweekly basis. As a result, the following practical steps have been identified:
- Current portfolios that invest in specific sectors will undergo an “ESG embedding” process. Analysts will adjust valuation models based on their analysis of an ESG materiality matrix to pinpoint ESG opportunities and risks. Portfolio managers could then make investment decisions based on ESG-adjusted recommendations.
- UBS SDIC is also keen to align investment goals with global Sustainable Development Goals. A new strategy around SDG-focused Chinese equities will be launched in Q1 2023, aiming to map individual SDGs with domestic portfolio holdings and keeping track of the engagement progress.
Collaborations in the QDII programme brought new perspectives and opportunities for investment research in domestic markets. Based on results from back-testing of domestic equities, a carve-out SDG-focused strategy, which resets off-benchmark positions to zero, has delivered considerable and sustainable alpha relative to the market index. The paper portfolio of SDGs equities has outperformed the benchmark by 2.11%, 1.13%, 2.31%, 5.38%, and 1.1% in the period 2017 to 2021.
UBS SDIC also back-tested the performance of ESG leaders based on its proprietary ESG ranking model. Over the past five years, the paper portfolio of ESG leaders (market cap weighted, no off-benchmark weight or sector tilts) contributed to 23.35% of total excess returns and had a Sharpe ratio of 0.39, compared to 0.19 for the market index. From the perspective of risk-adjusted returns and relative performance, the testing results can be seen as theoretical yet practical references for the financial impact of ESG integration.
In developed markets, it is common for active ownership activities to be undertaken by dedicated stewardship specialists.
The ESG taskforce at UBS SDIC reviewed the experience of collaborations in the QDII programme and decided to encourage equity analysts and portfolio managers to engage with corporates themselves.
Considering the different characteristics of domestic capital markets, direct involvement from investment experts benefits the efficiency of stewardship. For instance, portfolio managers at UBS SDIC have been communicating about ESG disclosures with companies that form part of their top holdings. According to feedback from engaged companies, communication directly from institutional portfolio managers has helped companies prioritise both short-term plans and long-term strategies that promote sustainable development.
The experience of integrating ESG factors into investment decisions for both foreign and domestic assets also helps us contribute usefully to discussions around ESG investment standards. UBS SDIC is proactively joining consultations to help bridge the gap between ESG investments in emerging and developed markets by sharing its findings and learnings.
In order to capitalise on the experience from the QDII programme by leveraging it in domestic strategies, extensive ESG research is needed. Low correlation of results from various ESG research providers can be confusing. The lack of transparency in rating methodologies makes it more difficult to interpret or consolidate different perspectives.
Our current approach is to keep investing in proprietary ESG research while the third-party rating industry matures and becomes more sophisticated. We also consider it to be good practice to communicate about ESG research with the sell side and engage more with listed companies to improve overall disclosure and data quality.
Although UBS SDIC aims to integrate ESG into investments for all assets under management, the internal taskforce has only applied this QDII approach for active equity strategies. Effective integration in other investments will need further research and innovation.