As of the end of July, there were 170 ESG-related open-type publicly offered toshin funds in Japan, with over JPY 3.8 trillion in AUM, nearly JPY 1.5 trillion of which was held by the AM One Global ESG High Quality Growth Equity Fund (unhedged).  ESG-related funds are increasingly offered as investment products by DC pension plans, thus establishing a genre in the toshin market.

Major ESG-related Funds for DC Pension Plans

in order of launching date

Two kinds of ESG-related toshin (not including ETFs) are offered publicly in Japan.  The first incorporates ESG screening as part of investment policy.  The second tasks investment managers specifically with applying ESG screening as part of their fiduciary duty.  The overwhelming majority of Japanese ESG funds is of the first type, with most having an environmental focus.  The second type is increasingly adopted by European asset managers, such as BNP Paribas which has implemented ESG standards in all its funds since September 2019.  The implementation of ESG standards in Japan is not at all common but is happening more often.

Quantitative evaluation based on investment performance alone is difficult, not only because ESG screening is conducted mostly on a fund-by-fund basis in Japan, but also because about 70% of all funds (on a unit basis) are relatively new, in operation for five years or less.  The same is true for ESG-related funds sold to DC investors.  Further, some nominally ESG toshin products are merely thematic investment trusts, which may never produce the expected environmental and social results.  In fact, the FSA's Expert Panel on Sustainable Finance has warned that thematic ESG funds may be ESG in name only.

I suggest DC managers keep two considerations in mind when selecting toshin products:

1) Do not invest in ESG only as an investment theme.

The essence of ESG investing is to focus on the process of earning returns and the quality of the resulting returns.  ESG is a framework for selecting investment targets, not a means for earning returns.  Even if a company is a good investment from a valuation perspective, if its ESG score is low or ESG-related risks are high, it is necessary to make the courageous decision not to invest.

For example, Morningstar in the US does not include either Amazon or Tesla in its “Morningstar US Sustainability Index”.  Amazon does not meet Morningstar’s social (S) adoption criteria and Tesla's carbon footprint in the electric vehicle manufacturing process has long been an environmental (E) thorn.  In Japan, Japan Tobacco, known for high dividends, and Nissan, although a while ago, were listed as gray investments from ESG point of view.

2) Learn about the management company’s investment philosophy and determine whether it aligns with your company’s values and goals.

Consult the management company’s website or reports on individual funds to see if you identify with its philosophy. Recently, companies have taken to revealing their rationales for selecting certain stocks in special reports and sales materials.  Even when a fund includes ESG darlings such as Google and Apple, it is important to know why they are there, for legitimate ESG reasons or merely as greenwashing.

** Data in the text are as of the end of July, 2021. **