TOKYO -- Companies are having to reckon how they stack up against an increasingly popular benchmark for investment: the environmental, social and governance criteria now applied to nearly 30% of global assets under management.
This worldwide trend in asset allocation has made for some head-scratching in corporate Japan and perhaps unpleasant surprises.
Last month, Pictet Asset Management launched a new investment trust focused on companies with strong environmental credentials. "Unfortunately, we won't be including Japanese automotive stocks," said Yasushi Nonaka, a portfolio manager in Japan. While Tesla of the U.S. made it in, Japanese car companies were deemed lagging on electric vehicles.
ESG investments totaled $22.89 trillion in 2016, according to the Global Sustainable Investment Alliance. The figure has increased 25% in two years.
Norway's Government Pension Fund Global -- the world's largest sovereign wealth fund -- has dropped six coal-heavy utilities from its portfolio, including Japan's Chubu Electric Power and Hokuriku Electric Power. It is a big investor here, holding around 1% of Japanese equities.
Among domestic institutions, the 149 trillion yen ($1.32 trillion) Government Pension Investment Fund has led the way in ESG investment, having allocated 1 trillion yen toward ESG indexes as of June and planning to eventually build up to 3 trillion yen.
Index providers like MSCI and FTSE Russell rate companies on ESG measures. This selection has had a visible impact on share prices. With more institutional investors picking stocks based on whether they fall into these baskets, Japanese names that do have outperformed the broad Topix index since the 2008 financial crisis.
More recently, two ESG high scorers -- industrial sensor supplier Omron and air conditioner maker Daikin Industries -- outstripped the Nikkei Stock Average over its 11-session winning streak through Tuesday.
Judging the judges
But many that fail to make the cut are left wondering. "We've run the numbers on inclusion, and we're not quite sure why we weren't selected" for some ESG indexes, said a source at Mitsubishi Heavy Industries, whose products include power plant, aerospace and railroad equipment.
Those making the decisions are hardly infallible, either. Kobe Steel, whose tampering with quality data came to light last week, remains part of an ESG index compiled by MSCI. Formerly rated 4 out of 10 on handling of scandals, the steelmaker has been downgraded to 1. Falling to zero would result in its removal from the index. Though it may hang on for now, the company's stock price has plunged nearly 40% since the scandal broke.
Investors can be hard-pressed to unearth from corporate disclosures alone details that management has sought to cover up. Still, "information other than financial data is crucial to determining the long-term value of a business," GPIF President Norihiro Takahashi said, highlighting the importance of ESG criteria.
With the recent parade of misdeeds by corporate Japan -- Kobe Steel's revelations follow deceptive accounting at Toshiba and other scandals -- understanding companies' internal controls and stances on social responsibility is growing more important than ever for investors.