[Contribution] ESG now mainstream

ESG investment trend to be further accelerated

Kim Dong-yang, senior analyst at NH Investment & Securities / Courtesy of NH Investment & Securities

By Kim Dong-yang

Part of the backdrop for the fast-paced economic growth of Korea, also known as the "Miracle on the Han River," are the dynamics represented by the common Korean phrase that translates to "quickly, quickly." Despite being a relative latecomer to responsible investment, which is the consideration of environmental, social and corporate governance (ESG) factors in making investment decisions, Korea is rapidly embracing adoption.

As one of the world's top-three pension funds, the National Pension Service (NPS) plays a significant role in responsible investment with its 900 trillion won ($770 billion) in assets under management (AUM). The NPS signed on to the U.N.'s Principles for Responsible Investment (PRI) in 2009, laid the legal basis for considering ESG factors with a revision of the National Pension Act in 2015 and is leading the spread of responsible investment in Korea via the introduction of stewardship codes in 2018 and announcement of plans to revitalize responsible investment in 2019.

According to the Global Sustainable Investment Alliance (GSIA), the world's responsible investment amount has grown at an annual average of 13 percent, from $13.3 trillion in 2012 to $35.3 trillion in 2020. As for Korea's responsible investment, the size of domestic equity-type publicly offered funds focusing on responsible investment has increased from only 200 billion won to 300 billion won to reach 2 trillion won in June 2021, climbing swiftly since the end of 2020 when the NPS announced its plan to hike the weighting of its own responsible investment ― expansion of responsible investment to over 50 percent of total assets by 2022.

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This accelerating trend is expected to continue for the time being, not only on the rising popularity of active ESG funds but also on the emergence of new ESG indices and an expansion of linked, passive ESG funds. In addition, the consideration of ESG factors when investing in bonds and alternative investments ― as well as stocks ― looks set to spread.

Moving ahead, ESG investment is likely to be shored up from a fundamental perspective by the gradual shift towards mandatory ESG information disclosure and the spread of ESG rating adoption, so long as asset owners such as the NPS remain willing to expand ESG investment, and ESG investment demand from retail investors increases, in turn further pushing up the scale of ESG investment.

The process of slowly making corporate governance reports ― related to the 'G' disclosure ― mandatory started in 2019 and is set to expand to all Korea Exchange (KRX)-listed companies by 2026. A similar process for sustainability reports ― 'E' and 'S' disclosure ― is to kick off in 2025 and expand to all KRX-listed firms by 2030. As more companies come to disclose their ESG information, thereby pushing up the scope of available ESG data, it is predicted that the creation of more meaningful data for the purpose of ESG comparative analysis will be fostered.

In the 2021 New Year addresses of large companies, ESG was the most frequently discussed term. Firms are now rushing to introduce ESG management systems, recognizing that to be chosen from an ESG investment perspective is essential to securing funds and improving corporate value.

With corporate governance reports gradually becoming mandatory, the compliance rate of companies' key governance indicators has risen. On top of that, ESG evaluation ratings are also improving. In addition to the expansion of mandatory disclosure, companies' voluntary introduction of ESG management systems promises to bring an overall upgrade to ESG ratings within the next three to four years.

Although it seems desirable to see Korean companies improving in terms of overall ESG status, it can be problematic for investors, as stockpicking becomes more difficult alongside the growing challenges of discerning firms based on ESG criteria.

However, such issues can likely be overcome through investment strategies such as "positive screening" through comparing a few core key indicators, and "negative screening" which relies on identifying controversy ― incidences or situations which are known to be detrimental to a company's ESG performance. In other words, if two companies have the same ESG score, it is preferable to choose the one with less controversy, both in terms of degree and frequency.

At the same time, as the complexity of ESG rating criteria and related methodology increases, the strength of individual indicators as differentiating factors tends to diminish. In this situation, for a final ESG investment assessment, a few "core" key ESG indicators can be selected. For example, noting that the cumulative voting requirement shows particularly low compliance, we may assume that a company showing a solid cumulative voting score is a standout performer in terms of ESG.

The writer is a senior analyst heading the ESG team at NH Investment & Securities.

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