Paul Schofield has worked at AllianzGI since 1998 and has managed client money since 2001. He is responsible for the management of some of AllianzGI’s sustainable equity funds as well as other global funds and contributes to the wider global equity platform. Paul was inspired to write this article on a recent visit to Japan.

I am fortunate that my role as a global portfolio manager allows me the opportunity for overseas travel on a fairly regular basis, but it is the Asian trips that I often enjoy most. Despite my affinity for the culture and people of the region, it has been the area I struggle most with when trying to pick stocks. Searching for companies that demonstrate high quality, growth characteristics through an Environmental, Social and Governance (ESG) lens has not, historically, been easy.

There is plenty of growth to be found across Asia and if you define quality as a company that can consistently generate returns above the cost of capital, then yes, I can find plenty of that also. But to find companies that have the returns I am looking for and the ability to grow those returns, whilst simultaneously managing the material ESG risks they face, well that list is quite short.

I find that the greatest challenge to this investment approach is the lack of ESG disclosure. This is not particularly an Asian phenomenon; thousands of companies across the globe publish little in the way of ESG data. The reason behind this? Simply, on the whole they don’t have to. Until companies are required to publish ESG metrics, something that is slowly starting to creep in, it can be a futile exercise to try to fairly compare peers. For example, simply because a European consumer company discloses significant details on its management of ESG risks does not automatically signify that they are superior to managing these risks than an Asian peer that does not provide any such disclosure.

However, based on the data that is currently available, I feel that on average Asian companies appear worse than their global peers at most things ESG. This is particularly clear in Japan where historically corporate governance has been weak relative to the rest of the world. When constructing an ESG focused global equity portfolio this can cause problems. Asia currently makes up about 19% of the MSCI ACWI1 index and if a Portfolio Manager (PM) is not careful he/she could be could be underweight the region based purely on ESG considerations. In saying that, had a PM been underweight Japan for the last 20 years he/she would have benefited as the country has significantly underperformed the rest of the world, but clearly that PM should now be more concerned about the future rather than the past. Will the downward trend continue or are changes afoot?

Whilst at this time Asian countries appear to be worse at ESG transparency than their global peers – this won't be for long. Often when I present the case of a new awareness and changing ESG landscape in Asia the general consensus is that change will be slow if it materialises at all. However, it is clear to me that we are at the beginning of a very powerful trend sweeping across Asia and it is time we started to pay attention.

As I started writing this paper in Tokyo, I will focus my attention on evolving ESG considerations in Japan. I have been visiting for ten years, yet this week long trip was my first to the country where I focused exclusively on ESG. The week ended with my participation in an ESG conference part sponsored by AllianzGI Japan (another first). I shared a stage with other respected global industry representatives to talk about ESG and how we each integrate it into our investment processes.

Japan is tackling the ESG challenge in a number of ways. From a regulatory perspective, the publication and enforcement of the Stewardship Code in 2014 and the Corporate Governance Code in 2015 have started to push Japanese corporate management towards more shareholder friendly behaviour – despite both only requiring companies to “comply or explain”. Such behaviours include using heavy cash piles to increase dividends and buybacks, unwinding inefficient cross shareholdings or introducing more independent board members, all of which should be applauded by shareholders. These are all behaviours we tend to take for granted from companies outside of Japan, but here it is significant and while it has been done in a, some would say, very Japanese style (i.e. respectfully and with little fuss) the changes are starting to be very significant indeed. For example, in 2004 70% of the First Section of the Tokyo Stock Exchange (TSE) had no independent directors at all. In 2010 that figure had fallen to a little over 50% but by 2016, as ESG considerations become more prominent, only 1.2% of TSE listed companies did not have an independent director on the board. Indeed today more than 80% of Japanese companies have two or more independent directors, this is clearly a positive step forward.

Figure 1: Board composition

Source: Japan, 2017: Voting/Proxy Season Review, Institutional Shareholder Services Inc, 29 September 2017.

At the very bottom of the above chart we can also see another very pleasing improvement in trend. The percentage of companies with at least one female director in Japan has increased from a little under 10% in 2012 up to 27.5% in 2017 – a very significant percentage increase but from an extremely low base. When we consider that in the S&P500 that figure would be over 95% we can see how much further Japan has to go.

The practice of cross shareholdings, where one company holds shares in another to strengthen business ties, has been on the decline for many years in Japan. This was a specific focus of the Corporate Governance code whereby companies are required to disclose and justify their policy regarding those cross shareholdings. Such a requirement further encourages corporates to think again about how best to allocate their capital and perhaps make the balance sheet work a little harder for investors, actively investing for their own business rather than just passively holding somebody else’s. The banking sector has historically been the worst offender of cross-shareholdings and all of the major banks have recently stated their desire to continue to unwind these shareholdings and for the most part, at a faster pace. This is a long-term project which won’t happen overnight, in fact, Goldman Sachs estimate that the six mega-banks in Japan are on target to unwind US$28bn of “strategic” shareholdings in 2018-21.2 Despite the time frame this is yet another positive step.

Dividends and share buybacks have increased significantly over recent years, again Goldman Sachs estimate a 76% increase in annual dividends and buybacks between FY2013 and FY2016. This is an increase of approximately US$63bn and that figure is forecast to rise in the coming years.

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