Through the Looking Glass
In the sequel to Lewis Carroll’s ‘Alice in Wonderland’, Alice climbs ‘Through the Looking-Glass’ and finds another fantastical world, absent of reason and where everything is reversed. This crisis of logic is all too evident when in investing in Asia Pacific.Download PDF version
So if I understand correctly, you’re saying your business model is based upon buying the rights to products that have been banned in Europe for safety and environmental reasons, and selling those same products into Asian countries which have yet to ban them?
The CEO nods enthusiastically. “Exactly!” He leans forward. “Environmental arbitrage! So long as they are legal in one or more countries, there is value left in them.”
More disbelief. It’s 2020. How is this still happening? This is a company which easily accesses society’s savings via the stockmarket. There is plenty of disbelief still to be had elsewhere among listed Asia Pacific companies. The power generation company which attributes its success to “not letting the women in.” The mining company whose dam collapsed, killing 19 people and polluting almost 700km of watercourses.
All are the easy recipients of society’s capital. Why?
In the sequel to Lewis Carroll’s ‘Alice in Wonderland’, Alice climbs ‘Through the Looking-Glass’ and finds another fantastical world, absent of reason and where everything is reversed. Time moves backwards. Events can be remembered before they happen. The right foot belongs in the left shoe. This crisis of logic is all too evident when investing in Asia Pacific. As the Red Queen says to Alice, “it takes all the running you can do to keep in the same place.” Sustainable investment in Asia Pacific is running hard now, but the goal seems to be getting further away. Rather than losing their licence to operate, such companies are having little difficulty accessing equity markets. Why?
Short-termism has for some time now been the prime suspect. As the investment industry has given way to the speculation industry, there is less emphasis on understanding long-term risks and opportunities and more focus on next quarter’s results and a quick trading profit.
But perhaps there is another, more fantastical culprit lurking in Alice’s Financeland in the shape of ‘metric fixation.’
Jerry Muller defines metric fixation as ‘the aspiration to replace judgement based on experience with standardised measurement’. Metric fixation would be at home in Alice’s Looking-Glass world. An ‘upsidedownbacktofront’ idea that wreaks havoc wherever it goes. Muller notes the damage wrought by metric fixation across all aspects of society from academia to policing to healthcare. So too with Asia Pacific investing.
Metric fixation must itself share some of the blame for short-termism. The obsession with performance-related pay based on short-term measurable outcomes has been a major contributor to shrinking time horizons of both companies and investors.
Metric fixation has also been instrumental in the relentless drive towards passive investment. Currently an estimated US$3.75 trillion1 of society’s savings are allocated passively to listed companies, based not on human judgement but rather on inert quantitative models. Before long, passive investment will be the primary means by which capital is allocated to listed companies in the Region.
The journey towards passive capital allocation has been a long and winding one, but its origins lie less in the search for cheaper costs and more in the desire to quantify and model investment risk. Metric fixation. The real risk of losing money from owning shares is complex and requires subjective judgement. But that is hard to model or count. Instead, the rise of metric fixation has led to the invention of benchmark risk.
Benchmark risk is another wonderful Alice character. It makes no sense. Why would losing 40% of an investment, but still outperforming an arbitrary index, be a good outcome? The closer a portfolio is to the index and some of its dubious constituents, the less ‘risky’ it becomes – and for as long as the industry continues to define risk in terms of deviation from arbitrary benchmarks, the outcome is an inexorable move towards passive investment.
And passive investment matters.
According to the WHO, tobacco kills more than one million Indians each year, accounting for 10% of all deaths in the country2. More than the global deaths from COVID-19 to date. Each year. So why does India’s largest tobacco company, with a market share of over 70%, have such easy access to society’s savings? With a market capitalisation of over US$30bn, its largest underlying shareholders are all passive funds. Why would society choose to allocate so much capital passively to a company that poses such health dangers? Looking-Glass absurdity.
Why isn’t the move towards sustainable investment in Asia Pacific counterbalancing this? Here too, metric fixation is causing trouble.
The obsession with quantifying Environmental, Social & Governance (ESG) is proving particularly challenging. Looking-Glass illogic is rife. The worse the company’s real sustainability impact, often the greater the likelihood of a high ESG score. India’s leading tobacco company has an AA ESG ranking and sits near the top of at least two ESG benchmarks, courtesy of its size and its sizeable ESG reports.
It is not just ESG scoring where metric fixation has warped the outcomes. Sustainable Development Goals (SDGs) mapping makes little sense but is fast becoming the norm. The Asian group hoping to source coal from a new mine next to the fast-bleaching Great Barrier Reef map themselves to the Education, Health and Sustainable Cities SDGs.
The requirement to quantify the impact of investor engagement with companies is also nonsensical. Improving access to affordable medicines. Phasing out toxic chemicals. Encouraging greater board diversity. Increasing tax rates. Improving working capital for smallholder suppliers. More governance checks and balances. Engagement success in these areas usually takes years and can rarely, if ever, be attributed to one actor. Even when it can, putting a dollar price on such qualitative aspects of impact is as nonsensical as the Looking-Glass Jabberwocky.
If metric fixation is a problem, what are the solutions? In the world of sustainable investment very little which counts can be counted or ‘metricated’, let alone standardised. Rather than produce banks of ESG data, the far greater challenge facing Asia Pacific companies and investors is to be authentic, resonant and imaginative when it comes to sustainability. These three characteristics do not lend themselves to metrication nor incentivisation. They require judgement and much effort to understand.
Is the approach to sustainability authentic and built upon a clear sense of purpose? Or a box-ticking, marketing-driven path towards short-term gain? Does it resonate across all aspects of the business? Or is it a marriage of convenience with little commonality? The coal company with the solar panels. The tobacco company with the award-winning eco-hotel business.
Is there evidence of imagination? The Asian bank which developed a successful mobile payments system, enabling millions of people in rural areas without access to bank branches to access simple savings products in a country where financial inclusion is still below 50%. The computer power supply company building an electric vehicle power business. Or is management stuck with a fixed mindset, unable to imagine how sustainability can be a driver of returns? The paint company still selling toxic paint where it is still legal to do so. The all-male board unable to imagine how to get from A to B.
Asia Pacific is home to many of the world’s greatest development challenges. According to the UN, 25% of the population still live in multidimensional poverty. Over 600m people still have to resort to open defecation3. Inequality. Water scarcity. Climate change. There are still plenty of companies which are part of the problem, exploiting vulnerabilities and cutting corners without consequence.
Fortunately, there are also plenty of wonderful companies in the region, full of purpose and resolve to address Asia’s development challenges. The medical diagnostics company providing over 40m affordable tests a year in a country which spends less than US$75 per person, per year on healthcare. The testing company helping to reduce the use of hazardous substances across supply chains. Prudent “micro-mortgage” providers helping to solve India’s 75 million unit housing shortage challenge. The sustainable plant-based nutrition company. Affordable medicines. The electric vehicle powertrain maker. The electric vehicle testing company. The solar inverter manufacturer.
None of these companies are perfect. Few of them have ESG data departments. Many have not mapped themselves to the SDGs. Most of them do not meet the requirements of the metric fixators. Investing in them creates benchmark risk. They are not the Region’s largest companies. They don’t automatically suck up large passive allocations of society’s capital. What they all have instead is an abundance of authenticity, resonance and imagination.
And in the long-run, authenticity, resonance and imagination are what is needed if we are to outrun metric fixation, passive investment and short-termism and escape Lewis Carroll’s fantastical Financeland.
Reference to any companies mentioned in this communication is merely for explaining the investment strategy, and should not be construed as investment advice or investment recommendation of those companies. Companies mentioned herein may or may not form part of the holdings of Stewart Investors.
View our list of investment terms to help you understand the terminology within this document.
Subscribe to our updates
To get regular updates and content from Stewart Investors, please register here.
This material is for general information purposes only. It does not constitute investment or financial advice and does not take into account any specific investment objectives, financial situation or needs. This is not an offer to provide asset management services, is not a recommendation or an offer or solicitation to buy, hold or sell any security or to execute any agreement for portfolio management or investment advisory services and this material has not been prepared in connection with any such offer. Before making any investment decision you should conduct your own due diligence and consider your individual investment needs, objectives and financial situation and read the relevant offering documents for details including the risk factors disclosure. Any person who acts upon, or changes their investment position in reliance on, the information contained in these materials does so entirely at their own risk.
We have taken reasonable care to ensure that this material is accurate, current, and complete and fit for its intended purpose and audience as at the date of publication but the information contained in the material may be subject to change thereafter without notice. No assurance is given or liability accepted regarding the accuracy, validity or completeness of this material.
To the extent this material contains any expression of opinion or forward-looking statements, such opinions and statements are based on assumptions, matters and sources believed to be true and reliable at the time of publication only. This material reflects the views of the individual writers only. Those views may change, may not prove to be valid and may not reflect the views of everyone at First Sentier Investors.
Past performance is not indicative of future performance. All investment involves risks and the value of investments and the income from them may go down as well as up and you may not get back your original investment. Actual outcomes or results may differ materially from those discussed. Readers must not place undue reliance on forward-looking statements as there is no certainty that conditions current at the time of publication will continue.
References to specific securities (if any) are included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. Any securities referenced may or may not form part of the holdings of First Sentier Investors' portfolios at a certain point in time, and the holdings may change over time.
References to comparative benchmarks or indices (if any) are for illustrative and comparison purposes only, may not be available for direct investment, are unmanaged, assume reinvestment of income, and have limitations when used for comparison or other purposes because they may have volatility, credit, or other material characteristics (such as number and types of securities) that are different from the funds managed by First Sentier Investors.
Not all First Sentier Investors products are available in all jurisdictions.
This material is neither directed at nor intended to be accessed by persons resident in, or citizens of any country, or types or categories of individual where to allow such access would be unlawful or where it would require any registration, filing, application for any licence or approval or other steps to be taken by First Sentier Investors in order to comply with local laws or regulatory requirements in such country.
This material is intended for ‘professional clients’ (as defined by the UK Financial Conduct Authority, or under MiFID II), ‘wholesale clients’ (as defined under the Corporations Act 2001 (Cth) or Financial Markets Conduct Act 2013 (New Zealand) and ‘professional’ and ‘institutional’ investors as may be defined in the jurisdiction in which the material is received, including Hong Kong, Singapore, Japan and the United States, and should not be relied upon by or be passed to other persons.
The First Sentier Investors funds referenced in these materials are not registered for sale in the United States and this document is not an offer for sale of funds to US persons (as such term is used in Regulation S promulgated under the 1933 Act). Fund-specific information has been provided to illustrate First Sentier Investors’ expertise in the strategy. Differences between fund-specific constraints or fees and those of a similarly managed mandate would affect performance results.
About First Sentier Investors
References to ‘we’, ‘us’ or ‘our’ are references to First Sentier Investors, a global asset management business which is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG). Our investment team operates under the trading name of Stewart Investors which is part of the First Sentier Investors Group.
This material may not be copied or reproduced in whole or in part, and in any form or by any means circulated without the prior written consent of First Sentier Investors.
We communicate and conduct business through different legal entities in different locations. This material is communicated in:
- Australia and New Zealand by First Sentier Investors (Australia) IM Ltd, authorised and regulated in Australia by the Australian Securities and Investments Commission (AFSL 289017; ABN 89 114 194311)
- the European Economic Area by First Sentier Investors (Ireland) Limited, authorised and regulated in Ireland by the Central Bank of Ireland (CBI ref no. C182306; Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland; Company no. 629188).
- Hong Kong by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. First Sentier Investors and Stewart Investors are business names of First Sentier Investors (Hong Kong) Limited.
- Singapore by First Sentier Investors (Singapore) (Company no. 196900420D) and this advertisement or material has not been reviewed by the Monetary Authority of Singapore. First Sentier Investors (registration number 53236800B) and Stewart Investors (registration number 53310114W) are business divisions of First Sentier Investors (Singapore).
- Japan by First Sentier Investors (Japan) Limited, authorised and regulated by the Financial Service Agency (Director of Kanto Local Finance Bureau (Registered Financial Institutions) No.2611).
- the United Kingdom by First Sentier Investors (UK) Funds Limited, authorised and regulated by the Financial Conduct Authority (FCA ref no. 143359; Registered office: Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB; Company no. 2294743).
- the United States by First Sentier Investors (US) LLC, authorised and regulated by the Securities Exchange Commission (RIA 801-93167).
- other jurisdictions, where this document may lawfully be issued, by First Sentier Investors International IM Limited, authorised and regulated in the UK by the Financial Conduct Authority (FCA ref no. 122512; Registered office: 23 St. Andrew Square, Edinburgh, EH2 1BB; Company no. SC079063).
To the extent permitted by law, MUFG and its subsidiaries are not liable for any loss or damage as a result of reliance on any statement or information contained in this document. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment products referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.
© First Sentier Investors Group