China specialists KraneShares has announced the launch of the KraneShares MSCI China ESG Leaders UCITS ETF (KESG LN) on the London Stock Exchange.

Jonathan Krane, CEO of KraneShares.

The fund, which is the issuer’s third UCITS ETF, is linked to the MSCI China ESG Leaders 10/40 Index.

The index provides exposure to large and mid-cap companies domiciled in China with high environmental, social and governance (ESG) ratings relative to their sector peers.

The index is weighted by market capitalization subject to an individual constituent weight cap of 10% and a sector weight cap of 40% to ensure diversification.

It derived from the MSCI China Index universe and includes A shares, H shares, B shares, Red chips, P chips and foreign listings (ADRs).

KraneShares argues that the underlying ESG methodology not only identifies more socially responsible investment opportunities but is also an effective filter for capturing companies that are aligned with the “New China” economy – namely knowledge-intensive companies that stand to benefit from a shift away from manufacturing towards a more services-based economy.

Since its inception in 2013, the MSCI China ESG Leaders Index has outperformed the standard MSCI China Index by 58%. The 5-year annualized return of the MSCI China ESG Leaders Index was 12.34% as compared to 7.49% from the MSCI China Index.

“We have seen a lot of investor demand for a China-focused ESG UCITS ETF,” said Jonathan Krane, CEO of KraneShares. “We are proud to partner with MSCI, a global leader in ESG indexing, to deliver the KraneShares MSCI China ESG Leaders UCITS ETF to our clients.”

Structural tailwinds

Chinese domestic investors and issuers are moving fast to incorporate ESG considerations in their decision-making, driven by strong regulatory initiatives to promote ESG practices and disclosures.

Some see China’s commitment to stricter environmental mandates and conservation efforts as necessary to achieve national goals of sustained economic growth. Already China is the world leader in total renewable energy capacity, at approximately 31% of total global capacity.

The current outbreak of coronavirus is only likely to add impetus to regulatory initiatives to promote ESG practices and disclosures as authorities not only crackdown on illegal practices within the food industry but also look to upgrade regulatory standards across the board – environmental, employment and corporate governance – in a bid to lessen the risks of similar potentially reputation-damaging and economically harming episodes occurring in the future.

Companies that are already integrating ESG considerations into their organizations – which the underlying index specifically targets – are likely to be better placed to thrive in this environment of increasing regulatory scrutiny.

Alongside this, the internationalization of China’s capital markets, including admittance to global investable equity and fixed income benchmarks, such as the important MSCI Emerging Markets Index and Bloomberg Barclays Global Aggregate Index, creates more of an incentive to align shareholder rights and governance policies with global standards, paving the way for Chinese companies to develop a more diversified shareholder structure.

This background suggests that an ESG-focused approach to China is a sensible and potentially lower risk route to gaining exposure to the country, thus making the ETF an appealing vehicle for investment managers looking to initiate a position in China.

The competition

The fund has been pitched competitively with a total expense ratio of 0.40%, materially cheaper than its nearest rival, the UBS ETF (LU) MSCI China ESG Universal UCITS ETF (CNSG LN) which is priced at 0.65%.

The UBS fund – the only other China ESG ETF listed in Europe – is linked to the MSCI China ESG Universal Index. This index is similarly based on the MSCI China Index universe and follows a methodology that first excludes stocks with the weakest ESG profiles as well as those involved in certain prohibited industries or embroiled in ESG controversies. The remaining constituents are then assigned an ESG factor score that reflects the firm’s current ESG profile as well as its trend in improving that profile. Securities are weighted based on a blend of free-float market cap and ESG factor score.

The UBS fund launched in July 2019 and has $8m in assets.