Developing a robust and effective ESG integration programme in China

Give a brief overview of your innovative approach to ESG incorporation, its coverage within your firm and why you decided to undertake this approach. 

Harvest’s China ESG programme involves proprietary ESG scoring and research, and regular ESG risk monitoring and alerts. The results are accessible on an ESG dashboard that is integrated into Harvest’s core investment platform.  

Harvest’s team of independent ESG specialists provides daily research support to investment and risk management teams, and portfolio ESG risk exposure is reviewed and discussed at regular investment committee meetings. 

The firm collects raw data from thousands of data sources using the latest AI technology. It uses the data to map material ESG issues and metrics through rigorous modelling, and then incorporates investment analysts’ qualitative views and first-hand information from direct contact with companies.  

It is aligned with globally accepted frameworks, but with China specific metrics added and scoring criteria adjusted to reflect local conditions and materiality. Under the framework, the entire China A-shares universe is scored, based on their ability to manage material ESG risks and opportunities. Factor effectiveness is ensured through rigorous testing, and results show that Harvest’s ESG factor is effective in capturing alpha in China. This approach is necessary because low ESG data quality and availability is a common barrier in the Chinese market.  

Harvest’s approach to ESG integration is unique in that the data collection, assessment, and decision-making process is internalised and customised to account for local market conditions. Fragmented ESG information is collected and aggregated at regional and firm levels to generate accurate, detailed, and timely information about investee companies. The ability to cover the entire A-share equities universe offers the benefit to derive meaningful insights about sectors and the market, which fills a current market blank. 

How does this approach stand out in the market? Why is it unique? 

• Harvest has put in place an ESG analytical framework that combines global best practices with the unique nature of local markets. 
• Harvest combines proprietary ESG data with third-party ESG data, including information gathered using artificial intelligence and Natural Language Processing technologies. 
• Harvest operates a full proprietary quantitative scoring of the entire China A-share market, based on a selection of over 110 material metrics, and fundamental coverage of the firm’s equity investments.  
• Harvest’s in-house ESG research is based on high levels of transparency on quantitative and qualitative inputs.  
• The ESG dashboard is integrated as a core module of the firm’s internal investment platform and database. 
• Sector analysts and portfolio managers are equipped and required to incorporate ESG insights when making investment decisions.  
• Similarly, all sector analysts are involved in the semi-annual qualitative assessment of material ESG issues through a sector-specific ESG questionnaire developed by the ESG team to supplement the quant scoring of investee companies. 
• Harvest engages with regulators, industry bodies, investors, and investee companies to promote and advise on various ESG related issues in the region, including awareness, reporting, sustainable practices and policies. 

Give a practical example of how you have applied your approach to an investment (security/issuer/sector/asset class/portfolio), including any challenges faced and how you adapted to them. 

Harvest’s ESG scores were used to develop a passive investing strategy for the A-share market. In November 2019, China Securities Index Co., Ltd. (CSI) launched the CSI 300 Harvest ESG Leaders Index. The index was constructed through selecting ESG leaders within each sector according to Harvest’s proprietary ESG scores, while maintaining sector neutrality to the benchmark CSI 300 index. The index delivered 4.7% in annualised excess return over the benchmark during the period of January 1, 2016 – March 31, 2020. This performance demonstrated that Harvest’s ESG factor offers the potential to generate alpha, and that ESG factors are material investment signals in the China A-shares market. 

A major challenge for the index development process is to determine the materiality of various underlying ESG metrics for Chinese companies, while ensuring that emerging and material issues are captured. To overcome this challenge, the ESG team collaborated with the quantitative and fundamental investment teams, and performed rigorous factor analysis, testing and optimisation for nearly a year. A wide range of construction methodologies were considered and debated adequately internally until the optimal version was finalised. The effectiveness of the final index methodology was subsequently validated by CSI. 

What were the outcomes of this initiative for the investment and how have you measured its success? What have you learned from this approach that can be applied more broadly? 

The ESG integration programme has given an alternative perspective on the investment process that was not very well understood before. And it will be a driver to enhance the overall quality of investment returns for investors into the future. 

In addition to the periodic publication of thematic, sector, and company ESG reports, the ESG team has provided a series of well-designed training programmes to all investment teams, and regular updates of ESG developments and investment trends through investment strategy meetings and internal ESG newsletters. 

Since the inception of the ESG integration programme: 

• Analysts’ understanding of ESG issues has been rising, measured by increasing references to ESG issues in research reports and investment recommendations.  
• All sector analysts have been trained on the governance assessment model, and have participated in semi-annual assessments of governance quality of investee companies. 
• Internal governance ratings and assessments have been systematically incorporated into internal investment ratings and valuation.  
• Sector analysts and portfolio managers have started to engage proactively with investee companies regarding ESG issues and areas of potential improvement. 
• As of April 2020, Harvest’s ESG scores have achieved 100% quantitative coverage in the China A-share equity markets, and 100% deep-dive qualitative coverage of the firm’s key holdings.  
• ESG scores and qualitative assessments have also shown to be important forward-looking indicators for management quality of companies, in many cases, and have been able to predict major governance failure and controversies of Chinese companies. 

In addition to this, the effectiveness of Harvest’s ESG scores has remained strong during the COVID-19 crisis: on average, the one-third of companies with highest ESG scores outperformed the one-third of companies with lowest ESG scores by 4.1% since the outbreak of COVID-19. And maximum drawdown was lower by 3.3%. 

Next steps are to ramp up portfolio-level requirements and to launch passive and active investment products based on Harvest’s proprietary ESG research, domestically and internationally. Harvest’s ESG integration programme will gradually extend to cover all major asset class and other markets.