UBS ETFs MSCI China ESG Universal

Investing in Chinese stocks with ESG screen. The rise of green China.

17 apr 2020

What are the sustainable options for investors in Chinese stocks?

The emergence of green in China

China has experienced unprecedented economic and financial expansion over recent years. Between 1990 to 2018 the average growth of its GDP was 9.4%, increasing from USD 360.9 billion to USD 13.6 trillion while their share of global GDP has swelled from 3.9% to 6.6%¹. During this rise to prominence the economy has become increasingly liberalized, and its capital markets have undergone far reaching changes with progressively improving access for foreign sources of capital.

Clearly the Chinese stock market is important for asset allocation, and the MSCI China ESG Universal Index forms a core building block for gaining ESG-filtered access to the Chinese economy. The objective of the MSCI China ESG Universal 5% Issuer Capped Index is to increase exposure to those companies demonstrating a certain minimum ESG profile as well as a visible trend of profile improvement. This is combined with seeking to exclude companies which are subject to severe controversies, or those involved in the manufacturing of controversial weapons.

The MSCI ESG Universal Index is a subset of the parent index MSCI China. The MSCI ESG Universal Methodology imposes a fairly light ESG screening, and remains highly correlated to the parent index which makes it a suitable replacement as a core allocation to Chinese stocks.

Investors now have the possibility to invest in Chinese stocks passively whilst taking into account ESG considerations.

  • As the first UCITS ETF, it provides an ESG-screened exposure to Chinese stocks.
  • Tracks MSCI China ESG Universal 5% Issuer Capped Index, which applies a robust ESG methodology to select and overweight stocks meeting certain ESG criteria.
  • Comparable risks and returns to standard MSCI China exposure with limited tracking error.
  • May be suitable for replacing core allocation to MSCI China.
  • Improving ESG profile without compromising investment objectives.

Investing in emerging market bonds

China has experienced unprecedented economic and financial development over the past decades. From 1990 to 2018, the average growth of its GDP was 9.4%, making it one of the most rapidly developing nations. Its GDP increased from USD 360.9 billion to USD 13.6 trillion, or from having 3.9% share in the global GDP to 6.6%.2

Along the way, the economy has become liberalized while its capital markets have undergone far-reaching changes and have progressively opened up to foreign investments. As of end-2018, the Chinese stock market capitalization has reached 6.3 trillion USD and was only second to the US.3

With its population of 1.4 bn, China is the most populous country in the world. China is heavily involved in geopolitics, which is exemplified by its recent trade tensions with the US. As the second largest economy in the world, China has a large and growing internal market. It therefore has the ability to conduct its own fiscal and monetary stimulus. The Chinese economy may therefore take its own path, and Chinese stocks may in the future exhibit a reduced correlation to other EM countries.

Figure 1: Percentage of global GDP per region/country

Source: World Bank Databank, UBS Asset Management. Data as of Dec 2018.

Figure 1 shows as comparison of the percentage of global GDP per region/country between 1990 and 2018.

Investment objective

The objective of the MSCI China ESG Universal 5% Issuer Capped Index is to increase exposure to those companies demonstrating both a certain a minimum ESG profile as well as a trend of improving that profile, all while seeking to exclude companies subject to severe controversies or those involved in the manufacturing controversial weapons.

Additionally, the ESG index aims to closely track the parent MSCI China Index. The ESG Universal methodology imposes a fairly light ESG screen, and it is highly correlated to the parent index, which makes it a suitable replacement as a core allocation to Chinese stocks.

After years of focus on economic growth, China has started to pay attention to ESG considerations. For example, the China Securities Regulatory Commission has introduced new requirements that will mandate all listed companies and bond issuers to disclose ESG risks associated with their operations in their annual or semi-annual reports.4 Therefore, ESG investing in China is likely to gain momentum.

Eligible universe

The Chinese stock market is characterized by a variety of listings and share types. Traditionally, foreign investors had a possibility to purchase the following:

H shares
incorporated in China; trade mostly in Hong Kong in HKD;

B shares
incorporated in China; trade in Shanghai and Shenzhen in foreign currencies (Shanghai USD, Shenzhen HKD);

Red chips
incorporated outside of China but usually controlled by the state, province, or municipality; trade in Hong Kong in HKD;

P chip
incorporated outside China, traded in Hong Kong, non state-owned;

Foreign Listings (ADR) – stocks of Chinese companies listed on foreign exchanges (NYSE, LSE, Singapore) and traded in foreign currencies.

Inclusion of China A shares

China A stocks represent around 40% of the Chinese total market capitalization.5 These are stocks registered and traded in China on the Shanghai and Shenzhen exchanges; quoted in renminbi and which entail foreign investments regulations (QFII). Due to their increasing accessibility to foreign investments, MSCI began including them in MSCI China Index from June 1, 2018. Currently, approximately 20% of the free-float of Large to Mid-Cap A-shares are part of MSCI China.

5 Based on a comparison of capitalization of MSCI China All Index and MSCI China A shares. Excludes non-indexed stocks

Construction of the MSCI China ESG Index

The starting point is the MSCI China Index, which is a broad exposure covering 85% of the eligible Chinese stock market capitalization.

MSCI China

  • Leading 703 Chinese stocks, ranging in size from USD 104 mn to USD 359 bn
  • Market cap of USD 2.13 tn
  • Broad diversification across sectors

ESG screening

The first step of the ESG screening is based on the following exclusions:

Criteria

  • Companies not assessed on ESG rating/and or Controversies
  • Controversy score
  • Involved in controversial weapons

Controversy scores
maintained by MSCI provide a timely assessment of ESG-related controversies and adherence to international norms and principles.

Controversial weapons
exclusions are based on MSCI specified criteria (e.g. landmines, cluster munitions, biological and chemical weapons, depleted uranium).

Weighting scheme

The securities from the eligible universe are weighted by the product of their market capitalization weight in the Parent index and the Combined ESG Score.

ESG Rating score

The ESG Rating score is defined by how well a company abides to the standard MSCI ESG criteria.

Using the MSCI ESG Rating, companies are grouped to assign an ESG Rating score to each company in the eligible universe as illustrated in the table above.

Rating Group

Rating Group

ESG Rating

ESG Rating

ESG Category

ESG Category

ESG Rating Score

ESG Rating Score

Rating Group

1

ESG Rating

AAA

ESG Category

Leaders

ESG Rating Score

2

Rating Group

2

ESG Rating

AA

ESG Category

Leaders

ESG Rating Score

2

Rating Group

3

ESG Rating

A

ESG Category

Neutral

ESG Rating Score

1

Rating Group

4

ESG Rating

BBB

ESG Category

Neutral

ESG Rating Score

1

Rating Group

5

ESG Rating

BB

ESG Category

Neutral

ESG Rating Score

1

Rating Group

6

ESG Rating

B

ESG Category

Laggards

ESG Rating Score

0.5

Rating Group

7

ESG Rating

CCC

ESG Category

Laggards

ESG Rating Score

0.5

ESG Trend score

The ESG Trend score shows the ESG rating change from prior to current. It is expressed as the number of levels between the current rating and the previous rating.

Trend Group

Trend Group

ESG Rating Trend

ESG Rating Trend

ESG Rating Trend score

ESG Rating Trend score

Trend Group

1

ESG Rating Trend

Upgrade

ESG Rating Trend score

1.25

Trend Group

2

ESG Rating Trend

Neutral

ESG Rating Trend score

1

Trend Group

3

ESG Rating Trend

Downgrade

ESG Rating Trend score

0.75

The rating trend is positive for a ratings upgrade (for example, the company’s ESG rating changed from BBB to AAA), negative for ratings downgrade, and neutral for no change in the rating.

The MSCI China ESG Index

The MSCI China ESG Index is obtained by applying the steps above. It also includes a sector-neutrality constraint and a 3% issuer cap to limit excessive concentrations. The resulting index provides a broadly diversified exposure to Chinese stocks with a similar risk-return profile to the parent index.

MSCI China ESG 5% Issuer Capped

  • Preserves broad diversification of the parent index
  • Leading 648 Chinese stocks meeting minimum ESG standards
  • Reweighted towards higher ESG-scored companies

Performance

MSCI ESG China Index has had similar performance over the past five years (Figure 2) compared to MSCI China, demonstrating its suitability as replacement of the core allocation to Chinese stocks. Interestingly, the performance of Chinese stocks (MSCI China) was much better compared to the broader EM universe with the difference over 5 year accumulating to 11.5%.

Figure 2: Performance Based on net Total Return in USD (Jan 31 2015 – Jan 31 2020)

Figure 2 illustrates MSCI ESG China index has had similar performance over the past five years compared to MSCI China, demonstrating its suitability as replacement of the core allocation to Chinese stocks.

Providing another perspective on the risks and returns of the indices under consideration, volatilities of MSCI China and its ESG equivalent are almost the same. The annualized return over the past 5 year on the MSCI China index is 6.83%, which is 83 bps above the ESG equivalent. However, this difference is period-dependent and the two indices actually had more similar returns if we considered full index history since Nov 30, 2012. Furthermore, these two indices exhibit a high correlation of daily returns equal to 0.99.

Figure 3: Risks and returns
Annualized Return and Volatility based on net Total Return in USD (Jan 31 2015 – Jan 31 2020)

Figure 3 provides another perspective on the risks and returns of the indices under consideration, volatilities of MSCI China and its ESG equivalent are almost the same. The annualized return over the past 5 year on the MSCI China index is 6.83%, which is 83 bps above the ESG equivalent.

Conclusions

China will be increasingly relevant for global equity portfolios. Investors now have the possibility to invest in Chinese stocks passively whilst taking into account ESG considerations. The return dynamics of the MSCI ESG 5% Capped Index are shown to be very close to those of the parent MSCI China Index portfolio.

Past performance is not a reliable indicator of future results.

Current fund performance data and further product information are available at www.ubs.com/etf.
Follow our #UBSETF

Passive/ETFs

Discover our indexing solutions

Important legal information

To proceed, please confirm that you are a professional / qualified / institutional client and investor.

UK:

This content is for professional clients only. It is not to be distributed to or relied upon by Retail Clients under any circumstances.

Other countries:

Views and opinions expressed are presented for informational purposes only and are a reflection of UBS Asset Management’s best judgment at the time a report or other content was compiled. UBS specifically prohibits the redistribution or reproduction of this material in whole or in part without the prior written permission of UBS and UBS accepts no liability whatsoever for the actions of third parties in this respect. The information and opinions contained in the content of this webpage have been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith but no responsibility is accepted for any errors or omissions. All such information and opinions are subject to change without notice but any obligation to update or alter forward-looking statement as a result of new information, future events, or otherwise is disclaimed. Source for all data/charts, if not stated otherwise: UBS Asset Management.

Any market or investment views expressed are not intended to be investment research. Materials have not been prepared to address requirements designed to promote the independence of investment research and are not subject to any prohibition on dealing ahead of the dissemination of investment research. The information contained in this webpage does not constitute a distribution, nor should it be considered a recommendation to purchase or sell any particular security or fund. The materials and content provided will not constitute investment advice and should not be relied upon as the basis for investment decisions. As individual situations may differ, clients should seek independent professional tax, legal, accounting or other specialist advisors as to the legal and tax implication of investing. Plan fiduciaries should determine whether an investment program is prudent in light of a plan's own circumstances and overall portfolio. A number of the comments in the content of this webpage are considered forward-looking statements. Actual future results, however, may vary materially. Past performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss.

© UBS 2020 The key symbol and UBS are among the registered and unregistered trademarks of UBS.

Reset