Responsible Investing in China
(Originally published October 2020)
It is undeniable that China’s influence on the global economy, global financial markets and geopolitical system is significant. From an economic standpoint it is the second-largest economy in terms of GDP and is slated to reach parity with the US in the next 10 years or so. In global financial markets, China represents 43% of the MSCI Emerging Markets Index and 5% of the MSCI All Country World Index as of August 31, which follows the United States and Japan. Moreover, 22% percent of the MSCI All Country World Index is non-Chinese companies dependent on the purchasing power of Chinese consumers to fuel their own companies’ sales and profit growth. On the geopolitical front, China continues to be an export machine supported by the country’s low-cost, skilled labor and efficient infrastructure.
However, the decision whether to invest in China is a complicated one, particularly to a responsible investor. The power and reach of China’s state-led model, its weak human rights record, lack of transparency, as well as heightened geopolitical tensions, can dissuade international investors from investing in Chinese companies or non-Chinese companies doing substantial business in China. Calvert’s viewpoint, however, is that it is preferable for a responsible investor to invest in China and engage as a shareowner, rather than divest. At Calvert, we believe as responsible investors we should fully understand the unique risks that investing in China may offer and weigh that against the return potential that a country with diverse people and a rich culture can offer in the form of both investment opportunities, in areas such as renewables, infrastructure, technology and consumer goods, as well as shareholder engagement. Engagement can create opportunity to be a part of positive change that advocates for business practices that can benefit the planet and the quality of life for billions of people.
Like many emerging-market economies, China is very much in development. While China’s GDP is second only to the US, its GDP per capita, according to 2019 World Bank data, is far lower, at $10,800 versus the US, at $65,118. This trails most Western countries and is more comparable to its emerging-market peers such as Mexico and Turkey. A strong civil society and legal system that provide effective checks and balances continue to be works in progress. At Calvert, we consider risks around data security, data access, legal protection, systemic corruption and political hazard to be key risks when investing in China, and ones we believe will grow in importance with China’s increasing economic influence.
Chinese internet security law, which took effect in 2017, requires that local firms allow the Chinese government access to individual privacy data in the interest of national security. Given China’s infamous record on protecting data of international firms and individuals, data security is a cause for real concern. This risk can lead to downstream reputational and liability hazard, as well as long-term national security concerns. The case of Yahoo reflects on ways this risk can materialize. Yahoo complies with Chinese authorities and openly acknowledges that the company cannot protect the privacy of China-based users. In 2005, when Yahoo provided data to the Chinese government, it led to the arrests and 10-year sentences of two Chinese activists. Yahoo was sued by the dissidents’ families, which eventually led to a settlement in 2007. As part of that settlement, Yahoo created a $17 million fund to support persecuted Chinese dissidents and their families.
Furthermore, data physically located in China is irretrievable by international regulators and firms. International auditing firms cannot retrieve data from their Chinese units. This can lead to problems for investors, affiliated auditors and international regulators. The case of China MediaExpress, an advertisement services provider, shows how problems surrounding data access can lead to losses for multiple parties. After being caught inflating revenues and stock prices, China MediaExpress was delisted by Nasdaq (2011), deregistered by the SEC (2012) and charged with fraud by the SEC (2013). In addition, Deloitte, KPMG, PricewaterhouseCoopers, BDO and E&Y were all charged by the SEC for refusing to hand over documents to aid the SEC’s investigations.
Another risk is China’s inconsistent application of legal protections, which may tend to veer on the rule by law, not the rule of law. The legal system is still developing, and is often influenced by powerful forces in politics and business. In previous decades, inconsistencies usually benefited international firms; more recently, inconsistencies have tended to benefit Chinese firms. We anticipate that this will continue as China protects domestic firms in certain sensitive industries. This risk is linked to unexpected legal action, particularly against people who are linked (even loosely) to sensitive issues. This risk materialized in December 2018, when Michael Kovrig and Michael Spavor were arrested by China and charged with criminal espionage days after Huawei’s CFO Meng Wanzhou was arrested by Canadian authorities and set to be extradited to the United States. Kovrig, a former diplomat, and Spavor, a high-level consultant, are both Canadians, and their arrests are almost universally seen as retaliation for Meng’s arrest in Canada. Kovrig and Spavor remain imprisoned in China.
Political tensions between Beijing and international actors can hurt Chinese and non-Chinese firms. This risk can cause serious financial damage to individual firms, potentially presenting material obstacles to established business models and growth strategies, and potentially impact the broader economy. The evolving saga around TikTok demonstrates the unstable environment that political hazard risks present for businesses and investors. President Trump’s executive order that threatened to ban TikTok was met with a recent update to Chinese law that could require ByteDance (the Chinese firm that owns TikTok) to obtain government permission for any sales of technology to a foreign company, potentially derailing any possible sales to Oracle, Microsoft and other non-Chinese suitors.
Finally, systemic corruption is another overarching risk. Similar to other emerging economies, vested interests at various levels of government operate in an opaque system. Networks of relationships often drive business and political decision-making processes. Many companies, such as GlaxoSmithKline (GSK), have faced reputational damage and steep financial losses due to their corrupt business practices in China. The case of GSK reflects how systemic corruption is relevant to both Chinese and China-exposed international institutions. GSK, the British health care giant with a history in China dating back to Imperial times, was involved in extensive corruption in its China operations. Company representatives bribed hospital officials and health care providers to push the company’s drugs for unlicensed uses. It also paid hush money to a patient who had health complications after using a drug that was not approved for the condition for which he was taking it, and GSK also attempted to bribe Chinese regulators. Moreover, GSK’s China operations were linked to a series of shell firms accused of money laundering. As a result, GSK had to pay a then-record $489 million fine to China in 2014, and several managers were deported and/or given suspended jail sentences. In the wake of the scandal, GSK’s sales and reputation plummeted in China.
Calvert believes that understanding these risks is essential when investing in China. We also believe that one can find attractive investment opportunities where the risk/return profile is favorable, given the growth potential in the country. As a responsible investor, engagement with management as a shareowner can also be a tool to drive positive change, whether improving working conditions for employees, pushing for stronger environmental practices or advocating for a move toward global norms of corporate governance. We are already seeing the Shanghai and Shenzhen exchanges move toward greater disclosure requirements around ESG issues. While overall disclosure requirements are not yet to the stringency of US and Hong Kong exchanges, the trajectory is positive. Responsible investors have a role in advancing these company disclosures so all investors can have a clearer understanding of material risks. By avoiding any Chinese exposure altogether, one loses that seat at the table.
Article by John Streur, President and CEO for Calvert Research and Management; Hellen Mbugua, Vice President and ESG senior research analyst for Calvert Research and Management; and Jade Huang, Vice President and Portfolio Manager for Calvert Research and Management.
See their biographies below.
References to individual companies are provided solely for informational purposes only and are intended only to illustrate certain relevant environmental, social and governance factors. This information does not constitute an offer to sell or the solicitation to buy securities. The information presented has been developed internally and/or obtained from sources believed to be reliable; however, Calvert does not guarantee the accuracy, adequacy or completeness of such information. Opinions and other information reflected in this material are subject to change continually without notice of any kind and may no longer be true after the date indicated or hereof.
As of August 31, 2020, Calvert portfolios hold the following companies within its integrated telecommunication services subindustry:
BT Group plc
Cellnex Telecom S.A.
Chunghwa Telecom Co, Ltd
Deutsche Telekom AG
Elisa Oyj Class A
HKT Trust and HKT Ltd
Infrastrutture Wireless Italiane S.p.A.
Nippon Telegraph and Telephone Corporation
NOS SGPS SA
Proximus SA de droit public
Royal KPN NV
Singapore Telecommunications Limited
Telecom Italia S.p.A
Telefonica Deutschland Holding AG
Telekom Austria AG
Telia Company AB
Telstra Corporation Limited
TPG Telecom Limited
United Internet AG
Verizon Communications Inc.
As of August 31, 2020, Calvert portfolios hold the following companies within its pharmaceuticals subindustry:
Astellas Pharma Inc.
Axsome Therapeutics, Inc.
Bristol-Myers Squibb Company
Chemical Works of Gedeon Richter Plc
Chugai Pharmaceutical Co., Ltd.
Dechra Pharmaceuticals PLC
Eisai Co., Ltd.
Elanco Animal Health, Inc.
Eli Lilly and Company
H. Lundbeck A/S
Hikma Pharmaceuticals Plc
Horizon Therapeutics Public Limited Company
Jazz Pharmaceuticals Plc
Kyowa Kirin Co., Ltd.
Merck & Co., Inc.
Novo Nordisk A/S Class B
ONO Pharmaceutical Co., Ltd.
Orion Oyj Class B
Otsuka Holdings Co., Ltd. Daiichi Sankyo Company, Limited
Perrigo Co. Plc
Reata Pharmaceuticals, Inc. Class A
Recordati Industria Chimica e Farmaceutica S.p.A.
Roche Holding AG
Royalty Pharma Plc Class A
Santen Pharmaceutical Co., Ltd.
Shionogi & Co., Ltd.
Sumitomo Dainippon Pharma Co. Ltd.
Taisho Pharmaceutical Holdings Co., Ltd.
Takeda Pharmaceutical Co. Ltd.
Vifor Pharma AG
Zoetis, Inc. Class A
Article Writers Biographies:
John Streur is president and chief executive officer for Calvert Research and Management, a wholly owned subsidiary of Eaton Vance Management specializing in responsible and sustainable investing across global capital markets. John is also president and a trustee of the Calvert Funds as well as a director of Calvert Impact Capital and member of its Risk Management Committee. He guided the creation of the Calvert Principles for Responsible Investment, the Calvert Research System and the Calvert Indices, and has placed focus on investment research and emphasis on environmental, social and governance (ESG) factors integrated with investment decisions. He joined Calvert Research and Management in 2016.
John began his career in the investment management industry in 1987. Before joining Calvert Research and Management, he was president and chief executive officer with Calvert Investments. He has managed socially responsible investments at the request of institutional clients, including public funds, religious institutions, and college and university endowments since 1991. Previously, he was president, director and principal of Portfolio 21, a boutique firm specializing in global environmental investing, and spent 20 years at AMG Funds (and its predecessors), a firm he co-founded and where he served as president, CEO and chair of the Investment Committee.
John is a Founding Member of the Investor Advisory Group of the Sustainability Accounting Standards Board and serves on Merck’s External Sustainability Advisory Council. John earned a B.S. from the University of Wisconsin, College of Agriculture and Life Sciences.
Hellen Mbugua is a vice president and ESG senior research analyst for Calvert Research and Management, a wholly owned subsidiary of Eaton Vance Management specializing in responsible and sustainable investing across global capital markets. She is responsible for environmental, social and governance (ESG) research in the apparel and retail industries. She joined Calvert Research and Management in 2018.
Hellen began her career in the investment management industry in 2009. She has worked with pension funds and asset managers in both public and private markets. Before joining Calvert Research and Management, she held senior investment positions at IFG Development Group and Adaris Capital Partners, both private equity firms focused on alternative assets. Prior to her work in private equity, Hellen was an associate director at Pacific Alternative Asset Management Company (PAAMCO), where she was an associate director covering multiple asset classes and participating in hedge fund co-investments. Prior to PAAMCO, she worked at State Street Corporation and Segal Consulting’s actuarial practice.
Hellen earned a B.S. from the University of California Santa Barbara and an MBA from the Tuck School of Business at Dartmouth College, where she was a Robert Toigo Fellow. She was born and raised in Kenya and speaks three languages.
Jade Huang is a vice president and portfolio manager for Calvert Research and Management, a wholly owned subsidiary of Eaton Vance Management specializing in responsible and sustainable investing across global capital markets. She is responsible for managing the suite of Calvert Responsible Indices, including the index construction processes, as well as developing new investment products at Calvert. She joined Calvert Research and Management in 2016.
Jade began her career in the investment management industry in 2005. Before joining Calvert Research and Management, she was a portfolio manager with Calvert Investments. Previously, she was an investment analyst at Microvest, an asset management firm specializing in impact investing, and led the certification department at Fair Trade USA. Jade earned a B.A. from the University of California, Berkeley and an M.A. in international finance and economics from Johns Hopkins University, School of Advanced International Studies (SAIS).