Recent readings of air pollution in Beijing to Tianjin put the dangerous air particles per million at a figure around 34 times higher than the recommended World Health Organisation levels.
The immediate impact on the quality of life of Chinese citizens is clear, and the National People’s Congress and Chinese People’s Political Consultative Conference are taking action.
However, analysis by Greenpeace suggests that despite efforts to reduce air pollution in Beijing, progress stalled last year with steel capacity actually increasing around the city as the country struggles to rebalance its economy.
China has a long history of government setting exacting environmental standards, but these have often not been implemented effectively due to the conflicts between the desire to improve the environment and grow the economy. In spite of this, there is optimism that the country is endeavouring to tackle environmental challenges as evidenced by the increase in fines and penalties for non-compliance.
An unconfirmed draft policy document is said to outline plans to cut steel and fertiliser production by at least half, and aluminium by at least 30 per cent in 28 cities across five regions during the 2017-18 winter heating season.
Cars and trucks are also huge contributors to pollution via combustion engines. China has put a meaningful effort into the development of electric vehicles, with subsidies for owners and regulatory penalties for original equipment manufacturers (OEMs) that fail to transition their model range to electric.
Investors should be positioned to identify businesses that can capture value on a global basis via strong business models and management teams. The best investments are often counter-intuitive and require diligent bottom-up research.
Rules of engagement: Chinese sustainable investing
Rule 1 – Local presence
Investors should seek out high-quality solution providers that have been present in China for more than 10 years as it is crucial to build local relationships, brand presence and distribution. A strong local presence will enable companies to react to local demand and leverage relationships and distribution to quickly grow their business in a profitable way. China is a very large addressable market and thus has sustainable long-term growth potential, but addressable markets are only a source of alpha [if] the business model and management can capture market share quickly and efficiently.
Rule 2 – Be in the right part of the value chain
Investment themes are easy to get exposure to because investors can simply screen for revenue exposure to the particular trend. But to capture value, investors need to invest in the right business model and management team. Electric vehicles are a clear sustainable growth theme, but do you invest in the OEMs, the battery manufacturers, or the materials suppliers? Traditional wisdom might suggest the higher up the value chain, the more value that can be captured, although other fundamental and valuation factors must be considered.
Rule 3 – Incremental inflection in China
Commodity sectors globally have rebounded meaningfully from their lows in 2016. Incremental changes in the supply or demand dynamic in China can have global implications – aluminium production is a good example. Chinese production is typically a carbon-intensive and dirty process, and production has been maintained on an uneconomical basis for some years. Shutdowns associated with recent pollution have been beneficial to aluminium prices globally. This incremental change in Chinese production levels has directly benefited European manufacturers, who expect to get the vast majority of their energy from renewables by 2020.
