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Allan Lane, Algo-Chain

KraneShares jumps the queue with China ESG ETF Launch


By Allan Lane, Algo-Chain – It is fair to say that China’s President Xi Jinping stunned the world with his recent announcement to the United Nations general assembly with his pledge that China would reach peak carbon before 2030 and for good measure drive down emissions to close to zero by 2060. 

By Allan Lane, Algo-Chain – It is fair to say that China’s President Xi Jinping stunned the world with his recent announcement to the United Nations general assembly with his pledge that China would reach peak carbon before 2030 and for good measure drive down emissions to close to zero by 2060. 

What is probably less well known was the level of high-fiving that went down in the offices of KraneShares following that pronouncement. It has been barely six months since they launched the KraneShares MSCI China ESG Leaders UCITS ETF and before you know it one of the world’s superpowers has stepped in and forced every commentator in the ETF eco-system to go back and take a second look at their environmentally friendly product.

Try as I do, I find it hard to talk about ESG issues before quickly struggling under the weight of so many important details, and that’s even before I’ve had a chance to put my investment manager’s hat on. Very occasionally though, and this is one such occasion, there does seem to be a very straight forward case to buy into the idea that the topic of China and environmental issues is a growth theme that is on a one way journey for some considerable time.

This ETF, launched in Feb 2020, aims to track the MSCI China ESG Leaders 10/40 Index and comes with an annual management fee of 0.40 per cent, which at the time of writing has close to 150 stocks which constitutes those with the highest ESG scores as deemed by MSCI’s selection criteria. From an asset allocation perspective, MSCI’s index caps the weights of any individual stock to 10 per cent and the exposure of any sector to 40 per cent. 

What matters to ESG aficionados though is the scoring system that MSCI uses to rank stocks. As an index provider one of the key challenges when designing an ‘ESG’ variant of a particular mainstream index is to deliver a product that displays the same risk/return characteristics as that parent index. At least for institutional investors that is. Once that is in the bag there is an argument to be had that any asset allocator just replaces one non-ESG aligned exposure with its ESG brethren. Let us face it, after the heavy lifting that the index provider and ETF manager have done, there isn’t that much left for the fund selector to do, so I’ll say this quietly, for a Discretionary Fund Manager it might be as simple as that – apart from the small fact that one has to understand the nuances of the different ESG scoring methodologies! Increasingly I have come to the view that it is the top five index providers that are shaping the future path of the investment management industry and not the likes of BlackRock as most observers might well believe. 

To get a handle on what is really going on in the ESG space in China, nothing beats drilling down into the factsheet to take a look at the type of stocks in the top 10 holdings list. Looking at the table below one can see that there is quite a range of initiatives that are driving the high ESG scores that MSCI’s methodology is placing on each of those stocks. These include re-cycling projects, energy saving measures in commercial office space and the issuance of green loans to fund low carbon transformation projects. High up the list of holdings is TenCent and Alibaba, perhaps two of the best-known internet brands of the modern era. While some may be surprised by their inclusion, let us not forget that Microsoft dominates many of the ESG funds that have been launched over the last few years.

KraneShares Chart

Click here to enlarge

Source: Bloomberg & KraneShares

Most, if not all, of the story represented through KraneShares’ China ESG fund dates back before President Xi Jinping made his announcement on 22nd September. If we take the president at his word, the scale of the challenge suggests China is set to undergo its next revolution. The last 20 years saw hundreds of millions of the rural population migrate from the countryside to the cities, driving the year-on-year GDP figures. Whereas what we are looking at now, according to The Guardian’s columnist Jillian Ambrose, would be nothing less than a complete inversion of China’s existing energy system. Ambrose’s analysis suggests that as fossil fuels currently account for about 85 per cent of China’s energy mix, and renewable energy makes up 15 per cent, these numbers would need to flip to meet the targets. 

I am only scraping the surface of this vast topic, but we could well be at the tipping point and only a matter of time before an avalanche of ETF launches will be driven by China’s decision to aim for a Carbon Neutral footprint, along with Europe it must be said.  And talking of footprints, when will the next shoe drop, and will that shoe belong to the next US President who might well want to re-join the Paris Climate Agreement? 

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