Hirn told FSA that her firm’s ESG strategy includes investing in companies “on the way to improving their ESG profile”. The idea is that a company in the early stages of adopting ESG practices will experience fundamental growth as the practices gradually spread improvements throughout the business.
“Then we can have a nice ride and know when to exit,” she said.
By comparison, she believes passive funds with an ESG strategy in emerging markets are underperforming because companies are added to an index fund too late, when they are already scoring high on ESG issues. When there is profit-taking or when the companies have lower earnings, the passive funds underperform.
“Passive ESG strategies are looking backward. Taking in information publically available and quantifiable, you’re not going into the qualities of companies and management.”
In Asia, the firm has an ESG niche strategy with its China environmental fund. She believes clean tech funds typically invest in the US and Europe, but China clean tech is ignored. In addition, the fund invests in China A-shares. “People are speaking about green bonds, but our fund is focused on green equities.”
"Instead of calling them out, we give them an ESG scorecard and show them where they rank and for what reason. It shows how they can make their stock look more attractive"
Hirn said Asian investors tend to hold outdated notions of ESG investing, confusing it with ethical investing.
“Ethical investing is about making an impact on social and environmental issues and ESG is completely different. We consider ESG criteria as important as other criteria in order for us to make a proper investment assessment. It’s related to the fact that best-in-class companies are doing good at everything in the business.”
Years ago, ESG was about exclusion screening, using criteria for risk avoidance. Now it is an integrated part of finding investment opportunities, she added.
She described East Capital as a boutique firm with some activist investor characteristics. The firm participates in shareholder voting and has lobbied management at annual general meetings in Eastern Europe and in Asia.
The firm creates proprietary “ESG scorecards” for each portfolio company, she explained. They are derived from a list of questions mostly focused on governance, which results in a grade. The scorecard is used as a tool to persuade management to change.
One example is the Russian airline company Aeroflot, which is a top ten holding in the firm’s Russia fund. Using the scorecard, East Capital found Aeroflot scored badly on environmental ratings because the company does not report its carbon footprint.
“We are pushing them to do it,” Hirn said. “Aeroflot has one of the youngest fleets in Europe and should be ranking high in terms of the carbon footprint, but management doesn’t report it. Instead of calling them out, we give them an ESG scorecard and show them where they rank and for what reason. It shows how they can make their stock look more attractive.”
She added that in 2015, her firm lobbied to stop Aeroflot from taking over Russian airline Transaero, which had filed for bankruptcy. Aeroflot had been under government pressure to take over the troubled airline, but “it would have been value destruction”, she said.
Up and down
East Capital has funds with niche strategies such as emerging Asia, Eastern Europe and frontier markets. It has no Hong Kong-domiciled funds, a requirement for selling products to mainland investors through the Mutual Recognition of Funds scheme.
In order to market to mainland investors, Hirn said the firm is looking for a China or Hong Kong asset manager to partner with.
In view of industry M&A activity, the specialised boutique firm would seem to fit nicely under a Legg Mason or BNY Mellon umbrella. But it is not open to being acquired.
“People have approached us but we’re not interested. M&A is defensive, it's a way to withstand potential challenges or firms don’t see how they can grow more. I don’t see us in that situation.
“Last year the Russian market soared. Russia this year has been the worst market year-to-date for us. But Russia is coming out of recession, inflation is low and companies have very high dividend yield. It’s been up and down for us. We’re strong enough to cope with potential turbulence,” Hirn said.
East Capital's China environmental and Russian equity funds versus their benchmarks over the last 12 months.
Fund NAVs and indices have been converted to US dollars for comparison purposes. Note that funds may be denominated in other currencies.