KESG ETF Review: Is ESG Investing in China Possible?
Investment opportunities in China are impossible to ignore, yet the country presents many environmental, social, and governance (ESG) risks. Enter KraneShares MSCI China ESG Leaders Index ETF (KESG), the only China ESG ETF. Despite its small size, over its one-year history, KESG performed much better than the broader Chinese stock market.
SustainFi Updated August 19th, 2021
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Why invest in China? What are the top environmental, social, and governance (ESG) risks in China?
Investors are looking to participate in Chinese growth. The world’s second-largest economy has committed to carbon neutrality by 2060. China is already the leader in renewable energy capacity, representing around a third of the world’s total, and has just launched the world’s largest carbon market. China also accounts for half the electric vehicles (EVs) sold globally.
However, the ESG risks of investing in China remain prominent, including concerns related to the crackdowns in Hong Kong, human rights abuses in Xinjiang, spotty corporate governance, and, more recently, regulatory initiatives targeting U.S.-listed Chinese stocks. China also remains the world’s largest emitter of greenhouse gases and continues to mine a lot of coal.
In light of this, ESG considerations are very important. In fact, companies with high ESG scores have outperformed the broader Chinese market by 68% between 2013 and 2020. And over the past year (through August 2021), the ESG-screened KESG ETF returned 14%, compared to a negative -9% for iShares MSCI China ETF (MCHI), which represents the broader Chinese stock market.
Chinese investors increasingly put money in ESG funds. Inflows in ESG ETFs in China hit $20.5 billion in 2019, more than four times the 2018 figure.
Chinese regulators require Shanghai, Shenzhen, and Hong Kong-listed companies to report ESG risks. Although Chinese companies still lag developed market peers in providing ESG disclosure, in 2019, 85% of Chinese Securities Index (CSI) 300 companies released ESG reports, up from 54% in 2013.
What is the KraneShares MSCI China ESG Leaders Index ETF (KESG)?
- Date launched: 2020
- Assets under management: $10 million
- Fee: 0.59%
KESG is the only broad market Chinese exchange-traded fund (ETF) that incorporates ESG factors in its stock selection. The fund seeks to track the MSCI China ESG Leaders 10/40 Index. Broadly speaking, KESG seeks to invest in large and mid-cap Chinese companies with high ESG ratings relative to peers. To diversify, no stock can exceed 10% and no sector can exceed 40% of the fund.
Launched in July 2020, KESG had about $10 million under management in August 2021.
What is KraneShares?
KESG and other KraneShares ETFs are managed by Krane Funds Advisors, a China-focused ETF provider. Krane Funds Advisors is a signatory of the U.N. Principles for Responsible Investing (UN PRI).
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How does KESG select stocks?
To come up with its investments, KraneShares:
- Selects the highest-rated ESG Chinese stocks from the MSCI EM Asia ESG Leaders Index
- Adds additional Chinese stocks with high (BB or above) ESG ratings from MSCI and MSCI Controversy Scores of 3 or better
- Excludes companies involved in thermal coal, tobacco, alcohol gambling, nuclear power, and weapons
What stocks does KESG own?
- Number of stocks: 176
- Fund assets in ten largest holdings: 50.5%
As of August 2021, KESG owned 176 stocks, though the top ten are over half the fund’s assets. The fund reflects the new economy with investments mostly in consumer discretionary (around 40% of assets), financials, and healthcare stocks.
The top three holdings are internet giant Alibaba (NYSE: BABA), China Construction Bank (HKG: 0939), and food delivery company Meituan (HKG: 3690). The top ten holdings also include Chinese EV manufacturers Nio (NYSE: NIO), known as “the Tesla of China,” and BYD (HKG: 1211). Any individual stock is limited to 10% and any sector to 40% of the fund.
Data as of 7/31/2021
Here are the fund’s top ten holdings:
| Holdings | % of Fund |
|---|---|
| Alibaba Group Holding Ltd | 7.9% |
| China Construction Bank – H | 7.2% |
| Meituan-Class B | 7.2% |
| Tencent Holdings Ltd | 7.1% |
| Nio Inc – ADR | 4.2% |
| Wuxi Biologics Cayman Inc | 4.1% |
| Ping An | 3.7% |
| China Merchants Bank – H | 3.5% |
| Li Ning Co Ltd | 2.9% |
| BYD Co Ltd – H | 2.7% |
Data as of 8/18/2021
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What are KESG’s ESG ratings?
- Fossil Free Funds Rating: C
- Fund assets in fossil fuels (Fossil Free Funds): 3.3%
- MSCI ESG Rating: Average (BBB on a scale from AAA to CCC)
- Holdings’ carbon intensity: Moderate (77.2 tons of CO2 / $ million in sales)
- Revenues from alternative energy: 14.2%
- Sustainalytics ESG Rating: 4 out of 5
KESG has good ratings from ESG rating providers Sustainalytics and MSCI. The fund owns relatively few oil and gas stocks (though it’s not 100% fossil free, according to Fossil Free Funds.)
The fund’s carbon intensity is about half of the overall Chinese stock market, represented by the iShares MSCI China ETF (MCHI).
| Fund | Expense Ratio | Holdings | Fossil Free Funds Rating | % Fund in Fossil Fuels | Carbon Intensity (tons CO2/$m sales) | MSCI Rating | Sustainalytics Rating |
|---|---|---|---|---|---|---|---|
| KraneShares MSCI China ESG Leaders ETF (KESG) | 0.59% | 176 | C | 3.3% | 77.2 | BBB | 4 / 5 |
| iShares MSCI China ETF (MCHI) | 0.59% | 551 | C | 3.3% | 144.7 | BB | 4 / 5 |
Data as of 7/31/2021
How has KESG performed?
Over its one-year history through August 2021, KESG performance has been much better than that of the Chinese market, measured by the iShares MSCI China ETF (MCHI). The fund is up 14%, vs. -9% for MCHI.
Compared to the broader Chinese market, KESG owns less tech stocks like Alibaba (NYSE: BABA) and Tencent (HKG: 0700). In contrast, it has more investments in healthcare and real estate. Only about a quarter of MCHI’s holdings meet KESG’s ESG screens.
Is KESG expensive?
- Expense ratio: 0.59%
Not really. KESG has an expense ratio of 0.59% ($59 annually on a $10,000 investment), the same as a broad market China ETF like MCHI. Emerging market, country-specific ETFs are generally pricier than diversified U.S. stock ETFs which can cost less than 0.05%.
What are the risks of investing in KESG?
The fund is tiny ($10 million in assets), and it could close unless assets grow. (You don’t lose your money if an ETF closes, but it can be an administrative annoyance.)
Further, the Chinese government has stepped up its scrutiny of Chinese companies listed on U.S. exchanges using the variable interest entity (VIE) structure. Some stocks KESG owns are listed in the U.S. using this structure, and Beijing regulators could revise foreign listing rules. It’s unclear if the rules would impact future listings only or both future and current listings. It’s not clear how a delisting would work, but share prices of Chinese stocks listed in the U.S. will likely suffer.
Alternatives to KESG
- KraneShares MSCI China Clean Technology Index ETF (KGRN)
You could also consider another ETF from KraneShares. KGRN focuses on clean energy companies based in China, investing along themes like alternative energy, sustainable water, green buildings, pollution prevention, and energy efficiency.
- WisdomTree Emerging Markets ex-State-Owned Enterprises ETF (XSOE)
XSOE is a diversified emerging markets ETF that avoids state-owned enterprises. Learn more about XSOE.
🔔 Interested in learning more about ESG funds? See our guide to ESG ETFs.
NOT INVESTMENT ADVICE. The content is for informational purposes only; you should not construe any such information as investment advice.
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