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  • Emerging Markets Equity

    Harnessing Growth: China at the Forefront of Sustainable Technology

    Dominic Jacobson, Analyst
    David Semple, Portfolio Manager, Emerging Markets Equity Strategy
    Oksana Miller, Product Manager
    June 25, 2021
     

    As the speed of the economic recovery from Covid-19 differs across countries, China’s economy is expected to close the year with an 8.4% growth rate. For reference, this far outpaces the U.S. growth rate of 6.4%. Beneath that top-line growth is a wealth of innovative, disruptive, forward-looking and sustainable investment opportunities. These companies are able to adopt progressive environmental, social and governance practices, commonly known as ESG, in order to enhance value across different industries and markets. Looking at these companies specifically also highlights some of the broader, prevailing themes in China at this time, including the emergence of Sustainable Technology1 (“SusTech”) within the A-Share market.

    Over the last year, the VanEck Emerging Markets Equity Strategy has increased its exposure to the China A-Share spacein a highly selective manner, given the precarious tradeoff between rich valuation multiples and strong secular tailwinds. Two lesser known A-share listed companies, Shanghai Baosight Software Co. (0.90% of the Strategy’s assets)and Hundsun Technologies Inc. (0.73% of the Strategy’s assets)4, we believe have compelling ESG business models, GARP-like characteristics and, collectively, exemplify the disruptive nature of China’s SusTech revolution.

    China and Its ESG Effort – The Rise of SusTech

    China’s sustainability effort has been accelerated as a result of the country’s ambitious 14th Five-Year Plan to transition towards a green economy. China’s commitment to net-zero carbon emissions by 2060 plays a key role in this transition and it is evidenced by its leading 5G platform (includes the Internet and mobile infrastructures), green tech (includes software development)5, food & agri tech, fintech, healthtech, smart cities and electric vehicle development. With a US$16T investment over a 40 year period (2021 is the 1st year of a 40-year journey of decarbonization), we view the adoption of Chinese SusTech exciting, as prominent companies transition, providing compelling opportunities for investment in the emerging markets space.6

    China’s New Ecosystem, Powered by Clean Tech


    China's New Ecosystem, Powered by Clean Tech

    Source: European Commission Joint Research Centre (JRC), Emission Database for Global Atmospheric Research (EDGAR) release version 5.0, Gao Hua Securities Research. Data as of May 31, 2021.

    China A-Share Market – Aligned with the Greener Future

    The progression of the China A-Share market has been incredible to watch. We believe it is one of the most liquid, dynamic and strategically important asset classes in the emerging markets equity space. Despite these attributes, we think it still remains under-represented in many portfolios and, perhaps, misunderstood by global investors more broadly.

    Within China A-Shares, we see the emergence of a new global investment theme in sustainable technology, where innovation and technology are creating lasting sustainable solutions for the next generation. We strongly believe that the A-Share companies which are at the forefront of developing technological solutions to sustainability issues offer some of the most compelling long-term investment opportunities.7

    SSE & SZSE – Total No. of Listed Companies

    SSE and SZSE - Total No. of Listed Companies

    SSE & SZSE – Total Market Value (100M)

    SSE and SZSE - Total Market Value (100M)

    Source: Wind. Data as of May 31, 2021. Note: Market data represents both Shanghai and Shenzhen markets.

    Another interesting observation is that the China A-Share market actually scores higher in Corporate Governance (G) versus China (ex-A) (please see below for the graph), further reiterating our investment case for active ownership and engagement in this “have to have” market.

    GS SUSTAIN: Corporate Governance Score

    GS SUSTAIN: Corporate Governance Score

    Source: Company Data, Goldman Sachs Global Investment Research, Bloomberg, Thomson Reuters.
    Data as of 8/17/2020. Note: Corporate Governance Score is based on ESG framework by GS Sustain. Ranked based on Independence & Accountability and Board Composition. GS Sustain scoring methodology and criteria: companies are percentile ranked relative to all companies in the MSCI ACWI Index on 12 standard governance metrics, which each have their own scoring methodology (please see below for the table). For additional detail regarding GS Sustain Scoring Framework, please refer to the GS Sustain Report “Long-Term Winners Series: Quality Matters, Issue no. 1, published on June 10, 2018.

    GS Sustain Governance Scoring Framework

    Framework scoring -1 0 (incl. data n/a) +1
    Independence & Accountability
    Director independence Director independence <33rd percentile (<43% independence) Director independence 33-67th percentile -OR-n/a Director independence >67th percentile (>78% independence)
    Independent leadership No independent chair or separate CEO/chair -AND- no independent lead director n/a Independent chair and separate chair/CEO -OR- independent lead director
    Executive compensation Say-on-pay vote <33rd precentile (<93.0% for) Say-on-pay vote 33-67th precentile -OR- n/a Say-on-pay vote >67th precentile (>96.7% for)
    Auditor independence Non-audit expense as % of audit fees >67th percentile (>24% non-audit vs. audit) -OR- significant auditor concentration (>10% of auditor total revenue) Non-audit expense as % of audit fees 33-67th precentile -OR- n/a Non-audit expense as % of audit fees is <33rd precentile (<7% non-audit vs. audit)
    Board elections Staggered board elections (excluding countries with provisions that allow shareholder to call an EGM with 5% or less shares) n/a Annual board elections (or staggered with provisions that allow shareholder to call an EGM with 5% or less shares)
    Shareholder rights & control Unequal voting rights -OR- state ownership n/a Equal voting rights -AND- no state ownership
    Anti-takeover provisions 'Poison pill' n/a No 'Poison pill'
    Board Effectiveness
    Board tenure Average board tenure >67th precentile (>8.6 yrs) Average board tenure <33rd precentile (5.5 yrs) -OR- n/a Average board tenure 33-67th precentile
    Board size Board size >67th precentile (>12 members) Board size 33-67th precentile Board size <33rd precentile (<10 members)
    Board diversity Female directors <33rd percentile (<10% female directors) Female directors 33-67th precentile -OR- n/a Female directors >67% (>22% female directors)
    Outside board affiliations Outside board affiliations >67th percentile (avg >1.9 outside boards per director) Outside board affiliations 33-67th precentile -OR- n/a Outside board affiliations <33rd percentile (avg <1.1 outside boards per director)
    Board skills Industry-specific or financial expertise <33rd percentile (<43% of directors) Industry-specific or financial expertise 33-67th precentile -OR- n/a Industry-specific or financial expertise >67th precentile (>64% of directors)

    Source: Goldman Sachs Global Investment Research

    Environmental “E” Explained:
    Baosight – China’s Green Tech Innovator Tasked to Reshape Steel Sector to Become More “E”

    China is currently the worst polluting nation on Earth and is the single largest producer of greenhouse gases globally (please see below for the chart).8  To reiterate, China’s sustainability effort has been accelerated as a result of the country’s ambitious 14th Five-Year Plan to transition towards a green economy – China’s commitment to net-zero carbon emissions by 2060.

    Within China’s industrial complex, the steel sector is the biggest offender, generating 15% of total CO2 emissions.Consequently, the steel sector has recently been caught in the cross hairs of policymakers, as the Chinese government sets its eyes on net zero carbon within the next 40 years.

    China accounts for the majority of global CO2 emissions from countries that have pledged net zero

    China accounts for the majority of global CO2 emissions from countries that have pledged net zero

    Source: Energy & Climate Intelligence Unit, Goldman Sachs Global Investment Research. Data as of May 31, 2021.

    As part of the government’s wide sweeping reforms, a higher concentration ratio has been targeted for the domestic steel industry. Policy makers believe consolidation will foster greater efficiencies through the adoption of cutting edge technologies and, in turn, promote a greener and more environmentally friendly industry. Baosight finds itself at the heart of this change – it is a software company listed in the A-Share market and its main business is digitizing the steel sector and making it more efficient through software and software enabled processes, such as combustion control systems for tempering furnaces and hot blast furnaces.

    Green Software: Combustion Control System for Hot Blast Furnace

    Customized software communicates with software embedded in all the production equipment. Data is subsequently collected, processed and analyzed in order to 1) optimize the combustion process, and 2) feed data back to other equipment to optimize their parameters. On average, it saves gas consumption by ~5% and reduces emissions of CO2 and other wastes.


    Baosight Software was born out of its parent group company Baosight Steel. Baosight Steel is the largest steel producer in China and is Baosight Software’s biggest customer.10 As industry consolidation takes its course, we believe Baosight will further cement its dominant position and, in the process, will merge and acquire smaller, lower quality peers, creating an economic “moat”.11

    Baosight’s competitive moat is built on its extensive knowledge of steel manufacturing. The steel manufacturing process involves various chemical processes, input of raw materials that vary in quality for very batch, additives that need to be added in varying amount and types depending on the raw materials’ quality and final product requirement. The entire process has approximately 2,000 parameters that need to be adjusted and monitored in real time to optimize energy consumption, cost and product quality. The embedded software has been customized for equipment on the factory floor of the steel mills and Integration of industry players will involve installing Baosight’s proprietary software in order to boost the productivity and efficiency of these companies.

    Baosight is a profitable company, pays a dividend and is expected to triple its earnings over the next three years and increase 12x over the next decade. It is currently trading 33x FY2022 year’s earnings – we view this as attractive, given the company’s highly visible earnings growth.

    We have been invested in Baosight since April 2021. We believe it is a high conviction name because of its forward-looking, sustainable and structural growth trajectory.

    Governance “G” Explained:
    Hundsun – China’s SusTech Solution Tasked to Build out Accessible & Compliant Capital Markets

    China’s capital markets currently represent one of the largest growth opportunities for financial institutions globally. By 2023, the country’s total addressable retail financial wealth is expected to reach US$30.2T.12 The policy backdrop is also favorable, with the government proactively working to help capital markets mature and liberalize, become even more transparent and compliant in order to grow retirement savings and meet pension obligations.

    In addition to being E-friendly as a digital platform, Hundsun Technologies is a leading SusTech solution tasked to build out an accessible and compliant capital markets ecosystem in China. The company is the largest IT solution vendor and supplier of financial software to capital markets participants in the country listed in the A-Share market.13 It has a quasi-monopoly over trading system software in China.

    In other words, if you are trading on an institutional level in China, you are likely using Hundsun’s services. In our opinion, the company’s dominance and economic moat is set to continue, given:

    1. High switching costs associated with changing vendors – not only in terms of money spent but also significant disruption on day-to-day operations of these businesses
    2. Leading edge technology – R&D expenses represent 40% of total revenue and 3x more than its next closest competitor in dollar terms
    3. Execution and reputation

    Hundsun’s target addressable market (TAM) is expected to grow exponentially over the next decade. UBS and Credit Suisse estimate that broker and wealth management industry respective revenues will triple over the next ten years and that IT spending will double – suggesting that Hundsun’s TAM could theoretically increase by 6x by 2030.

    Total IT investment in China’s financial institutions was just US$23B in 2019 – lower than JP Morgan, Citi, Bank of America, Morgan Stanley and Goldman Sachs combined investment, which was US$25B. For example, in 2019 Morgan Stanley’s IT investment expenditure alone was greater than China’s entire securities industry.14

    History suggests that China’s asset management industry growth has and will continue to be accompanied by capital markets reform. These reforms drive software upgrades as a gradual introduction of more sophisticated financial service offerings and this trend will most likely be accompanied by a sustainable buildout of IT infrastructure.

    We have been invested in Hundsun since December 2020. We believe it is a high conviction name because of its forward-looking, sustainable and structural growth trajectory.

    Conclusion

    Beyond sustainable technology investment opportunities, China continues to be the fastest growing major economy in Asia. We expect China’s equity market to be supported by business models and responsible company management, strong earnings and a better liquidity outlook. We remain positive in the outlook for China A-shares as well.15

    For nearly twenty years, VanEck’s Emerging Markets Equity Investment Team has worked hard to identify forward-looking, sustainable and structural growth companies across sectors and industries. As active, bottom-up investors, the Team evaluates companies across a wide range of ESG and sustainability factors. The assessment of these ESG-related risks and opportunities is integrated into the Strategy’s investment philosophy, process and portfolio construction.

    DISCLOSURES

    Information regarding portfolio composition, portfolio composition methodology including ESG considerations, investment process and limits, or valuation methods of evaluating companies and markets are intended as guidelines which may be modified or changed by VanEck at any time in its sole discretion without notice. The Strategy may invest in securities of issuers whose ESG practices are currently suboptimal, with the expectation that these practices may improve over time.

    The term “Sustainable Technology”, “SusTech” or “CleanTech” describes technologies that use significant savings in terms of use of amounts of materials and energy.

    As of May 31, 2021, the China A-Share market comprised 4.92% of the total portfolio. Other A-Share portfolio holdings include Ping An Bank Co., Yifeng Pharmacy Chain Co. and Qingdao TGOOD Electric Co.

    Source: VanEck. Data as of May 31, 2021. For illustrative purposes only, as a SusTech, A-Share market portfolio name.

    Source: VanEck. Data as of May 31, 2021. For illustrative purposes only, as a SusTech, A-Share market portfolio name.

    Green Tech is an umbrella term that describes the use of technology and science to create products and services that are environmentally friendly.

    Source: Bloomberg, Goldman Sachs Global Investment Research. Data as of May 31, 2021.

    Source: Bloomberg, Wind, Goldman Sachs Global Investment Research. Data as of May 31, 2021.

    Source: Bloomberg, Goldman Sachs Global Investment Research. Data as of May 31, 2021.

    Source: Bloomberg, Goldman Sachs Global Investment Research. Data as of January 20, 2021.

    10 Source: Jefferies. Data as of March 7, 2021.

    11 A moat is a sustainable competitive advantage that is expected to allow a company to fend off competition and sustain profitability into the future.

    12 Source: Deloitte. As of November 12, 2019.

    13 Source: UBS. As of May 31, 2021.

    14 Source: Credit Suisse. As of November 27, 2020.

    15 Source: Bloomberg. Data as of May 5, 2021.

    Please note that VanEck offers investments products that invest in the asset class(es) or industries included in this commentary.

    ESG investing is qualitative and subjective by nature, and there is no guarantee that the factors utilized by VanEck or any judgment exercised by VanEck will reflect the opinions of any particular investor. Information regarding responsible practices is obtained through voluntary or third-party reporting, which may not be accurate or complete, and VanEck is dependent on such information to evaluate a company’s commitment to, or implementation of, responsible practices. Socially responsible norms differ by region. There is no assurance that the socially responsible investing strategy and techniques employed will be successful.

    The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources is believed to be reliable and has not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

    This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. Strategy holdings will vary.

    Emerging Market securities are subject to greater risks than U.S. domestic investments. These additional risks may include exchange rate fluctuations and exchange controls; less publicly available information; more volatile or less liquid securities markets; and the possibility of arbitrary action by foreign governments, or political, economic or social instability.

    ESG investing is qualitative and subjective by nature, and there is no guarantee that the factors utilized by VanEck or any judgment exercised by VanEck will reflect the opinions of any particular investor. Information regarding responsible practices is obtained through voluntary or third-party reporting, which may not be accurate or complete, and VanEck is dependent on such information to evaluate a company’s commitment to, or implementation of, responsible practices. Socially responsible norms differ by region. There is no assurance that the socially responsible investing strategy and techniques employed will be successful.

    ESG integration is the practice of incorporating material environmental, social and governance (ESG) information or insights alongside traditional measures into the investment decision process to improve long term financial outcomes of portfolios. Unless otherwise stated within the Fund’s investment objective, inclusion of this statement does not imply that the Fund has an ESG-aligned investment objective, but rather describes how ESG information is integrated into the overall investment process.

    All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

    Van Eck Associates Corporation

  • Authored by


    David Semple
    Portfolio Manager, Emerging Markets Equity Strategy

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    Oksana Miller
    Product Manager