Using total portfolio management to gain China, ESG exposure

Investors can use a total portfolio risk and active management approach to gain exposure to Chinese assets without a negative impact on overall sustainability profile, according to Willis Towers Watson.

Investors are interested in allocating capital to Chinese investment, but are mindful of managing ESG related risks and opportunities, Willis Towers Watson notes. By looking at risk factors in aggregate across portfolios, investors can 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.

"The total portfolio approach considers each risk factor in aggregate across the entire portfolio," says Liang Yin, director in Willis Towers Watson's investments research team and China project lead. "That increases the flexibility to spend the so-called sustainability budget across asset classes. It allows us to reduce exposure to assets with negative sustainability characteristics in the portfolio elsewhere and increase exposure to Chinese assets with better sustainability momentum and better overall risk and return potential, while increasing exposure to assets with positive sustainability characteristics, such as investment in climate solutions, to balance the overall sustainability profile."

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.

"[Asset owners] need a set of guiding principles to provide a consistent framework for identifying good practice across all asset managers, as well as a way to guide engagement with those managers," Yin said. "We want to make sure that sustainability principles and polices are set by the leadership and then transmitted through the firm via an effective culture."

When evaluating potential external fund managers, ESG integration comes under the microscope.

"The second principle is integration of ESG information, making sure there are appropriate resources in place that can be used to identify, measure and manage material ESG information," Yin said. "The third aspect is stewardship - we want to see good engagement with key stakeholders on sustainability issues. We want to see in the area of public equities voting records, and then the fourth is really that point about improving the system - we like to see practice that asset managers undertake to engage with us and really improve the investment system to make it more sustainable, in particular in addressing systemic risks such as climate change."

"The investment case is really three-fold," Yin said. "China has the world's second largest economy, and the world's second largest capital market, and those markets offers substantial depth, breadth and liquidity. Its economic cycle runs at a different frequency to that of the developed world and hence including Chinese assets offers good diversification properties."

The second pillar is that there is plenty of opportunity for active managers to add value.

"The third pillar of the investment case is by adding Chinese assets into the portfolio, it improves the portfolio's resilience with regards to a changing and uncertain world order. Global investors' portfolios to date are still highly geographically concentrated. If you look at MSCI ACWI, it has a weight of 60% to the US and a weight of less than 5% to China ...

"We will say that by adding Chinese assets to portfolios, they improve the portfolio resilience with regards to uncertainty."

Read more: USESGChinaWillis Towers WatsonLiang YinMSCI ACWI