Japanese fund managers avoid the local market when placing ESG bets

Japan’s top fund managers seem to have reached a consensus on the allocation of their sustainable investment portfolios: anywhere but Japan.

The country’s four largest environmental, social and governance (ESG) funds have invested at least 95% of their net assets in foreign stocks as of this month, according to data compiled by Bloomberg, spending only a small fraction of their 1.4 trillion yen ($12.1). billion) to national assets.

It’s a blow to Japanese companies looking to ride the wave of investor money flowing towards companies that meet a combination of criteria for ESG factors.

Big funds like Asset Management One Co.’s Global ESG High Quality Growth Fund and Sumitomo Mitsui DS Asset Management’s Innovative Decarbonization Strategy Fund say there are fewer Japanese companies that meet their ESG criteria. Analysts add that overall, returns are better elsewhere.

“It’s obvious to investors that these US giants have an advantage over Japanese companies when it comes to capital firepower,” said Hideyuki Ishiguro, senior strategist at Nomura Asset Management.

Last year, the Japanese government’s pension investment fund, an early pioneer in ESG investing, sharply reduced its primarily Japan-focused investments due to concerns about low returns. Of the seven ESG indices tracked by GPIF, six underperformed the benchmark Topix index over the past year. Returns from non-Japanese holdings also outpaced those in the domestic market.

Analysts say these low returns coupled with less progressive government policies are creating an uneven playing field. Japan’s decades-long underperformance relative to its foreign peers also adds to this ESG disadvantage. To make up the difference, institutional and individual investors are looking abroad.

“There are greater expectations for stock price gains for overseas stocks, which stem from the gap in management’s ability to adapt to a changing generation,” said Mitsushige Akino, senior executive at Ichiyoshi. Asset Management Co. in Tokyo.

A spokesperson for Asset Management One said when its investment team looked at the bottom-up analysis on high-quality ESG names, limited Japanese companies stood out. Nomura said US stocks were the most attractive in their selection process.

Sumitomo Mitsui DS also said US equities topped the list when looking for innovative funds in reducing emissions. “The weighting may change depending on where these companies can be found in the future,” spokeswoman Satoko Matsushima said.

The S&P 500 index rose 27% in 2021, setting records on a weekly or monthly basis, while the benchmark Topix index gained 10%. The underperformance of Japanese equities was also visible across the various funds.

Asset Management One’s Global ESG Fund gained 9.6% last year, while Nomura’s globally mandated Nomura Environmental Leaders Strategy Fund B Course rose 24% . In contrast, Sumitomo Mitsui DS’ domestically focused Japan Equity ESG Fund rose 5.7%.

ESG investing aims to allocate capital according to less traditional metrics such as a company’s ability to reduce carbon emissions, promote board diversity and improve employee well-being.

On some measures, Japan is a notable laggard. Women make up just 18% of Japanese corporate boards, according to data compiled by Bloomberg, one of the lowest in the world and nearly half of the US average of 30%. The median percentage of women in senior management is also half of the United States.

Environmental measures also show that Japanese companies are lagging behind. The total greenhouse gas or carbon dioxide intensity per million dollars of revenue for S&P 500 companies is about three-quarters that of Topix, according to data from Bloomberg.

Many Japanese funds invest heavily in the United States if their prospectus allows it. For ESG funds, however, there is an additional cost: it means that Japanese companies are not rewarded for good environmental, social or governance practices like their foreign competitors.

Toyota Motor Corp., for example, has a stronger ESG record than Tesla Inc., according to scores from rating agencies such as S&P, Sustainalytics, ISS and Bloomberg, and last month unveiled plans to invest 4,000 billion yen to accelerate its push into electric vehicles. . Despite everything, Tesla obtains the first place of the ESG fund of Sumitomo Mitsui DS.

In some cases, investors looking to move away from companies in their own backyard could work against them. While Tesla outperformed Toyota last year, its shares are down nearly 19% this year, compared to the latter’s 4% gain.

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