Assessing the impact of green bonds Nikko Asset Management March 2024 The green bond market has experienced tremendous growth since 2007, but despite its rapid success, there are still barriers to overcome. In particular, assessing the impact of green bonds continues to be a contentious topic. Due to a lack of standardisation among both issuers and regulators, gathering, grouping and communicating fund-level impact data is challenging, as are efforts to ensure green bonds continue to represent the interests and requirements of investors. Nonetheless, measuring the impact of green bonds is an essential component in ensuring their continued success. Which metrics matter most to green bond investors? As one would expect given the increasing appetite to understand the real impact of investments, most green bond investors track alignment with the United Nations Sustainable Development Goals (SDGs). SDGs are a great basis for mapping the use of proceeds to clear and understandable environmental and social outcomes. Indeed, many of the most common metrics required by investors - including greenhouse gas reductions, CO2 emissions avoided and carbon intensity--have become established components in impact reports from issuers. Please see an Environmental Finance survey from 2022 in Charts 1 and 2. Green, Social, Sustainability and Sustainability-Linked Bond Principles designed by the International Capital Market Association (ICMA) have been widely accepted as the common framework to provide transparency on the issuance of labelled bonds. All issuers aligned to ICMA Principles are committed to report on the allocation of proceeds, which is generally accompanied by impact metrics. While the IMCA Principles are a useful starting point to gather and compare how proceeds are being used by issuers, and the impact they have, the principles themselves are broad and not prescriptive. This means that the reporting quality and consistency between issuers can still vary widely. Some issuers will report their allocation on an aggregated portfolio basis, rather than on a bond-by-bond basis. Others may not specify what proportion of a specific project is financed by the green bond proceeds--making it almost impossible to measure bond-specific impact. In recognition of this, while adhering to IMCA Principles is a good starting point, investors seeking to meaningfully understand the impact of green bonds and want to be able to compare and contrast between different green bonds, continue to demand better quality impact reporting from bond issuers, and increasingly look to do so through issuer engagement. Chart 1: What environmental metrics are your firm most interested in? Source: Environmental Finance survey (2022) Chart 2: What are your firm's main criteria when choosing a green bond fund to invest in? Source: Environmental Finance survey (2022) Engagement throughout the lifecycle The IIGCC Net Zero Bondholder Stewardship Guidance advocates a long-term financing lifecycle-based approach. This presents a useful illustration on how engagement can support better impact measurement and reporting. The lifecycle includes the following steps: Pre-issuance engagement based on financed emissions, refinancing pipeline, and net zero alignment. Issuer and issuance alignment of climate and net zero commitments, targets and covenants, and monitoring this alignment over time. Collaborative approach across the bond market ecosystem including issuers, investors, Debt Capital Markets (DCM) syndicate, banks, SPOs, rating agencies, index providers, regulators and policymakers. Engagement progress and outcomes to clearly link stewardship to investment decisions, and steer responsible capital allocation. Chart 3: Bond market ecosystem Source: https://www.iigcc.org/resources/net-zero-bondholder-stewardship-guidance Regulatory challenges New 2023 requirements surrounding the introduction of the EU Taxonomy have imposed additional regulatory responsibilities on fund managers. While initially focusing on climate environmental objectives, 2023 revisions have included a wider set of sustainably-orientated economic activities, namely: Sustainable use and protection of water and marine resources Transition to a circular economy Pollution prevention and control Protection and restoration of biodiversity and ecosystems Nikko AM's perspective is that although the EU Taxonomy is helpful for determining whether an economic activity can be considered environmentally sustainable​, it is not the only approach and is less well adapted to companies beyond the EU. The EU Taxonomy could be considered as sometimes too stringent in its quantitative demands, given the availability and quality of data. Currently we do not use the EU Taxonomy to measure impact in our own funds. That said, we do recognise it has value in terms of monitoring, as well as highlighting certain key elements that any sustainable investment process should possess. What next for green bond fund impact reporting? Although impact reporting among green bond issuers is improving, the quality and consistency of impact reporting can still vary significantly. Without being properly addressed, this lack of standardisation on reporting could have deeper consequences for the industry as a whole. The lack of consistent data is not only an issue for our own analysis but also for our client's reporting expectations. The less transparent an issuer is, the less likely the bond will be included in a sustainable fund. However, progress is being made, and the global significance of green bonds means that specialist data providers are increasingly looking to provide comparable impact data for analysis and reporting, using assumptions and methodology to understand impact. Funds operated by this manager: Nikko AM ARK Global Disruptive Innovation Fund, Nikko AM Global Share Fund Important disclaimer information Please note that much of the content which appears on this page is intended for the use of professional investors only.

China and India's contrasting inflation front Nikko Asset Management October 2023 The implications of inflation Inflation--the increase in the general price level of goods and services in an economy over a timeframe--has become one of the most closely watched economic gauges in recent years as consumer prices hit record highs. Besides bearing significant influence on standards of living, economic growth and the direction of interest rates, inflation also has significant implications on the top-down development of countries as well as the bottom-up fundamentals of companies. On a top-down basis, inflation signals the strengths and weaknesses in the overall economy and drives the policies and responses of governments and central banks, either being supportive or restrictive. From a bottom-up perspective, inflation signals whether certain industries have the pricing power to pass on the changes in costs and to generate sustainable returns from future investments. In other words, inflation encapsulates changes in both the overall economy and the operating metrics of a company. Moreover, inflation can have political implications, particularly in the developing world, as it is often a key issue in elections and can impact the popularity of elected politicians. That is why investors in the emerging markets often pay close attention to the general development of consumer prices, plus the outlook of inflation. Indeed, how a government navigates inflation often affects future investment returns. In this article, we compare and contrast two of emerging Asia's largest economies, China and India, through the lens of inflation. Today, China and India face opposite inflationary pressures, which could alter the outlook for these two large emerging economies. Inflation in China is close to zero, while that of India is above 6% (as of August 2023). Year-to-date (YTD), as at end-September 2023, the renminbi has depreciated more than 5% against the US dollar (USD), whereas the India rupee is flat versus the greenback. Equity markets also seem to be rewarding one and punishing the other; Indian equities (as measured by the MSCI India Index) were up 8.0%, in USD terms, on a YTD basis (as at end-September 2023), while China stocks (as measured by the MSCI China Index) were down 7.3% YTD. China faces deflationary pressures Let us begin with a close look at China. Concerns that China could be facing a deflationary spiral arose when the country reported that consumer inflation dropped by 0.3% YoY in July, the first decrease since February 2021. Since then, consumer prices in the world's second largest economy have moved higher, rising by 0.1% YoY in August, allaying fears a persistent deflationary trend in the nation. Headwinds from falling property prices and the decline in construction activity due to its ailing real estate sector are likely to cause more lingering deflationary pressures, in our view. Very low inflation or deflation can directly impact consumer behaviour. First, it can lead to a decrease in consumer spending as consumers may delay purchases in anticipation of lower prices in the future. This can lead to decreased economic growth and job creation. Second, low inflation can compound the debt burden. As the real value of debt increases due to the lack of inflation, this could lead to increased financial stress for households and businesses. At the same time, low inflation can discourage investments as investors may seek higher returns in other countries with higher inflation rates. And if subdued inflation persists for an extended period, it can lead to a deflationary spiral where prices continue to fall, potentially leading to a long-term economic stagnation. The big picture is that Chinese economic growth has been on a declining trajectory since the 2008 Global Financial Crisis (GFC). Having said that, if China were to achieve its government's targeted GDP growth of 5% for 2023, that would still be a decent result for a maturing economy (see Chart 1 for China's real GDP growth, inflation and real interest rates). Chart 1: China's real GDP, inflation and real interest rates Source: Bloomberg, August 2023 More broadly, China currently faces several structural issues. It has negative population growth, a heavy debt burden in certain areas (namely property), an oversupply of goods, weak export markets and tight monetary policy. China's monetary policy has historically been on the tighter side, averaging 3% in real interest rates. Despite its recently flagging economy, China's current real interest rates still stand at 3%. There have been times when real rates in the country were lower, such as during the GFC and around the period of global economic weakness of 2015. This time around, the People's Bank of China (PBOC) is using alternative measures, like cutting mortgage rates incrementally and reducing banks' reserve requirements to boost overall liquidity. In our view, the Chinese government and the PBOC need to do more to stimulate the economy. Monetary policy loosening at a drip-feed speed is not creating a positive environment for the Chinese markets. Indeed, consumer and investor confidence in China is fading. Portfolio flows are negative and foreign investors are net sellers of Chinese equities. Nonetheless, it is not all bad for the world's second largest economy on the inflation front. One of the positives is that China is still seeing some inflation on the services side, which accounts for 40% of the inflation basket. Services-related inflation is rising at 1.3% on average, compared to overall consumer inflation at 0.1% YoY (as at August 2023). Historically, China's services-related inflation had hovered between 2-3%. During the COVID-19 lockdowns, it fell below zero. A rise in services consumer price index (CPI) is good for the overall inflation picture in China, which is growing more slowly in recent years and whose growth is largely due to government spending. All in all, China needs inflation to move higher. Higher commodity and agriculture prices could lead spur Chinese inflation Going a step deeper into the drivers of inflation in China will show that agriculture prices (namely those of soybean and pork) and commodity prices (including hydrocarbons, which are the main components of oil and natural gas) are closely related to the direction of inflation in the country (see Chart 2). As such, rising commodity prices and higher agricultural prices could pose an upside risk to inflation in China. A surge in China's inflation in 2019, for instance, was partially attributed to the outbreak of swine flu in 2018, which caused an increase in pork prices amid a drop in supply. Chart 2: China's inflation and commodity prices move in tandem Source: Bloomberg, August 2023 COVID-19 further distorted the time series of inflation in China. Since the country's re-opening earlier in 2023 (and the absence of disease or other disruptions to supply), agriculture consumer prices look to have bottomed. Agriculture inflation in China is trending around 2% and could lift overall Chinese CPI. The same is true of rising commodity prices. Oil prices have recently risen above USD 90 per barrel. China imports around 59% of its oil needs, making it the largest oil importer globally, and higher oil prices will support inflation in the country. There is, however, a risk of stagflation if rising commodity-driven inflation is accompanied by low growth. Indeed, without productivity gains or other spending increases, inflation without growth for China may be problematic for the world's second largest economy. Chinese inflation and its impact on equity markets The Chinese equity market, as measured by the MSCI China Index, is trading close to the lowest price earnings (PE) multiples in 20 years, with very low growth priced in by the market. During the 2010-2015 period, equity valuations in China fell with declining inflation. Over that period, the market return in China averaged 1.5% on an annualised basis. Without dividends, it was negative. Today, China is once again experiencing a period of low and declining inflation, which coincides with the downturn of its equity market. However, if Chinese inflation starts to rise due to higher agriculture and commodity prices and looser monetary policy, we do expect a better showing for China stocks. This is because corporate sales and earnings per share (EPS) growth rates tend to have a positive correlation with inflation (see Chart 3). Chart 3: China's corporate sales and EPS growth are positively correlated with inflation Source: Bloomberg, August 2023 Earnings growth in China has been decelerating since 2005 and hit bottom in 2016, when China implemented a massive monetary stimulus that lifted global equity markets and Chinese earnings. The effects of that stimulus have worn off, and the Chinese equity markets are now back to the lows of 2016. Chinese earnings growth is in a difficult position; it needs a forthcoming and large stimulus, which, in turn, will help lift inflation in the country. After China's last set of quarterly results, earnings revisions for 2023 and 2024 were negative; growth expectations, though positive, are also falling. We have looked at the annualised three-year sales growth of corporate China, working under the assumption that it takes time for inflationary pressures to work through a company's operations. Our expectations are for Chinese inflation to rise to 2% in 2024 and sales growth to follow suit. If that materialises, it would be a good result for Chinese earnings growth. All things considered, the Chinese equity market needs a source of higher profitability, and rising inflation, amongst other factors, could be key to invigorate profit levels. India at a sweet spot Viewed through the lens of Inflation, India is at the opposite end of where China is. India's Inflation, while above the Reserve Bank of India (RBI)'s target of 4%, isn't looking too elevated, as compared to its historical averages. Inflation in India has slightly eased to 6.83% YoY in August (from 7.44% in July) and is currently in line with the country's average annual inflation rate, which over the past few decades has been around 6-7%. As we see it, the Indian central bank remains accommodative, keeping real rates close to zero. The country's political climate is pro-business. The government of Indian Prime Minister Narendra Modi is in its third year of running large budget deficits, and with the coming general elections in 2024, the administration is unlikely to tighten its budget strings in the foreseeable future. At the same time, high oil prices have yet to hit the Indian economy, which is still relying on cheap Russian oil. India's annual GDP growth has hovered steadily in recent years, generally between 6% and 10%, while inflation has moved around the same levels as GDP growth (see Chart 4). India is in a sweet spot at the moment as inflation is trending lower, yet it is at a faster rate than GDP growth. Chart 4: India's real GDP, inflation and real interest rates Source: Bloomberg, August 2023 The RBI tends to keep a closer eye on real GDP growth than inflation. In times of rising real GDP growth, the central bank has tightened monetary policy and loosened policy during periods of declining GDP growth. Expectations are for the RBI to continue to be accommodative, given that there are elections in 2024. Future agriculture prices key to India's inflation India's inflation basket is heavily weighted towards food, which makes up almost 37% of the CPI basket, while fuel comprises 5-6% of the total. Agriculture prices, on a YoY basis, have flattened, giving respite to inflationary pressures in India (see Chart 5). If there are any shocks to the global food supply, from either an escalation of the Ukraine-Russia war or from weather-related events, that could be a potential risk to inflation in India. Overall commodities, though rising largely because of higher oil prices, do not have that much of an impact on inflation in India. Chart 5: India's intertwined Inflation and commodity prices Source: Bloomberg, August 2023 The Indian equity market and its link with inflation In India, the earnings yield, which is the inverse of the PE multiple, tends to move in tandem with inflation. During the commodities super cycle at the turn of the century, the Indian stock market did very well as inflation trended higher and valuations rose. Today, the environment looks similar. Inflation is high, growth expectations are rising and the market is starting to perform well. India's earnings growth, which is reaching historic highs, could mean persistently higher inflation. However, stand-alone valuations in the country are not excessive and rising rates haven't dampened investor sentiment. Relative to cash, equity valuations look fair, our view. Likewise, sales and earnings growth in India, historically, have had a fairly good relationship with inflation. In the post pandemic period, we have seen a divergence, however. Inflation has flattened and is expected to decline over 2024, while both sales and earnings are expected to continue to rise. Still, we reckon that if the country's sales and earnings were to remain strong in 2024, that would be supportive of higher rather than lower inflation. All in all, the Indian equity market looks well-placed with inflation under control, supportive monetary and fiscal policies. And with investors looking for alternatives to China, the uptrend in the India equity market could last for a while. Overall, the Indian equity market is pricing in a longer growth cycle; earnings growth expectations remain high, while strong macro tailwinds should continue to support the corporate sales and earnings rebound. Key takeout In China, inflation is at near-zero levels, and the country faces deflationary pressures. We believe that earnings expectations need to be adjusted lower in China, while the debt-fuelled growth and debt-supported return on equity is a thing of the past. In our view, the Chinese government and the PBOC need to do more to stimulate the economy, and China needs inflation to move higher. If inflation in China starts to rise due to higher agriculture and commodity prices and looser monetary policy, we do expect a better showing for China stocks. In India, inflation, while above the RBI's target of 4%, is not looking too elevated, as compared to its historical averages. Strong macro tailwinds are expected to continue to support the sales and earnings rebound in India. Government policies, both fiscal and monetary, are accommodative, with the RBI keeping real rates close to zero. But higher commodity and agriculture inflation could pressure earnings growth by late 2024. Author: Mohammed Zaidi, Investment Director Funds operated by this manager: Nikko AM ARK Global Disruptive Innovation Fund, Nikko AM Global Share Fund Important disclaimer information Please note that much of the content which appears on this page is intended for the use of professional investors only.

Climate change solutions in Japan Nikko Asset Management September 2023 "Hottest on record" is on repeat In scenes now repeated every summer, not a day seems to go by without headlines of record-high heat somewhere on the planet, whether in Europe, Asia, Africa or North America. The World Meteorological Organization said it was "extremely likely" that July 2023 will be the hottest on record1. As temperatures climb, news images of raging wild fires have become all too common, along with other hallmarks of extreme weather such as violent storms and destructive flooding. We have been spared the worst of extreme weather patterns here in Tokyo. Nevertheless, we have acutely felt the impact of climate change. In Tokyo this August the mercury rose above 30 degrees Celsius every day of the month for the first time since records started being kept in 1875. As the country becomes more tropical in climate, long-standing traditions are being challenged. An example is in baseball, Japan's national pastime. The sport is usually played without any breaks. However, a "cooling time" rest period was introduced for the first time at the 105th edition of the National High School Baseball Championship, a nationwide tournament held annually in August. This break with tradition caused a national debate, with many of us wondering if children in the future will even be able to enjoy pastimes long associated with the summer in this country such as tennis, soccer and rugby? It is no secret that greenhouse gas (GHG) emissions play a role in global warming. Yet, despite pledges by governments around the world to reduce GHG output, global emissions have been increasing steadily (Chart 1). Our tendency to ignore a looming catastrophe was satirized in the 2021 movie Don't Look Up. Two astronomers played by Leonardo DiCaprio and Jennifer Lawrence discover a comet hurtling towards earth and warn the world of the impending disaster, but to no avail. In desperation, the two scientists beg the world via social media to just look up, but the US president, portrayed by Meryl Streep, advises to do just the opposite, telling people "don't look up". Chart 1: Global GHG emissions and corresponding temperature change World total GHG: Total greenhouse gas emissions including land-use change and forestry, measured in million tonnes of CO2-equivalents.World temperature change from GHG: Change in global mean surface temperature (in °C) caused by greenhouse gas emissions. Source: Out World in Data material compiled by Nikko AM Japan: a major GHG emitter with room for improvement Unlike fictional characters in a movie, in reality we have no option but to look up and consider what is driving climate change. Let us take our home market of Japan as an example. The country was the seventh largest GHG emitter in 2021 (Chart 2). Japan's significant emissions are a result of its heavy reliance on fossil fuels to generate power, having slashed its dependency on nuclear power plants following the earthquake and tsunami-induced nuclear disaster in 2011. Chart 2: The world's top GHG emitters Source: Our World in Data material compiled by Nikko AM Seen from a different perspective, being a large GHG emitter means there is plenty of room for Japan to improve its environmental standing. In 2020, the country made an ambitious pledge to reach carbon neutrality by 2050, and in 2021, it set a goal to cut GHG emissions 46% by 2030 from 2013 levels. The share of renewable energy that generates Japan's electricity has risen to 22.4% in 2021 from 12.1% in 2014, according to the Institute for Sustainable Energy Policies2. There are other concrete signs that Japan is indeed improving its standing, in particular among its private sector. As Chart 3 shows, Japan has the highest number of companies that support the Task Force on Climate-Related Financial Disclosures (TCFD). Upon request by G20 central bankers and finance ministers, the Financial Stability Board established the TCFD in 2015 to help the financial sector assess and price climate-related risks as well as opportunities. The TCFD Recommendations were released in 2017 and widely credited with shaping the voluntary climate-related financial disclosure landscape. However, whilst support for the TCFD is encouraging, the quality of disclosures still has room for improvement. Chart 3: TCFD-supporting institutions by country as at July 2023 Source: TCFD Consortium material compiled by Nikko AM Awareness towards sustainability within Japanese society is expected to increase, with companies taking a more proactive role in promoting it. Interest towards ESG investment is also rising among individual investors, led by those of the younger generation. According to a survey by Japanese news provider QUICK's ESG Research Center, 48% of respondents in their 20s were interested in ESG investment, compared to 44% in their 30s and 42% in their 40s3 . Equity strategy focused on climate change In addition to Japanese companies and individuals, awareness towards sustainability is also increasing among the country's financial institutions and investors. Until recently, only a few financial institutions disclosed their financed emissions, which are GHG emissions linked to investment and lending activities. However, more such institutions are now hiring sustainability specialists to estimate their financed GHG emissions, and their disclosure is seen gathering pace going forward. Against such a background, we expect increased demand among investors to reduce GHG emissions linked to their investments. One strategy asset managers use to meet such demand for portfolios with lower GHG emissions focuses on urging companies to accelerate decarbonisation efforts via stewardship activities. Nikko AM's climate change-focused Japanese equity strategy takes such an approach (Exhibit 1). Exhibit 1: Climate change-focused Japanese equity strategy's objectives Source: Nikko AM The strategy covers all sectors to construct a low-GHG portfolio, providing exposure to Japanese stocks that is similar to the TOPIX while simultaneously aiming to limit financed emissions. As at end-July 2023, the portfolio's estimated tracking error versus the benchmark TOPIX was 0.34%, of which the estimated risk attributed to industry allocation was a modest 0.13%. GHG emissions and intensity are maintained approximately below 50% of those of the benchmark TOPIX (Exhibit 2); GHG emissions by companies are based on publicly disclosed information as well as estimates calculated using an in-house model. Exhibit 2: Portfolio-wide GHG restrictions and targets4 (KPIs) Source: Nikko AM A key feature is the utilisation of in-house GHG emission estimates, which enable us to expand our coverage significantly from approximately 600 companies to the entire TOPIX universe of roughly 2,100; the weight coverage has also increased from 82% to 100%. We are able to cover almost the entire TOPIX on a market cap basis through the use of our own estimates as well as actual reported results. In addition to such a quantitative approach, another important feature is engagement with the investee companies. The quantitative data obtained is utilised in engagement undertaken by Nikko AM's Sustainable Investment Department. This interaction encourages companies to operate in a more environmentally conscious manner and disclose relevant information (Exhibit 3). The department's on-the-ground stewardship specialists are well positioned to leverage Nikko AM's influence on investee companies. Their well-established relationships with local companies give Nikko AM an advantage over foreign peers. In addition, our stewardship activities in all global regions follow the highest international standards, with the firm having been recognised in 2023 for the second consecutive year by the UK's Financial Reporting Council as a signatory to the UK Stewardship Code. Nikko AM was the first Japanese asset manager accepted to the Code based on a global, firm-wide application. Exhibit 3: Driving decarbonisation initiatives through engagement Source: Nikko AM Engagement example: a major Japanese steel company Engagement: The company initially aimed for an 18% reduction of CO2 emissions by FY2024 from FY2013 levels. Considering the company's standing as a major emitter, we conveyed the need for a more ambitious target by first using existing technology. We also encouraged the company to actively seek government support in its emissions reduction efforts. Company response: The company revised its CO2 reduction plan and now aims to reduce its emissions by 30% by FY2030. It explained that the plan would be achievable through the introduction of new procedures, mainly the effective use of raw materials; practical utilisation of digital transformation within the production process is also expected to play a role in reducing emissions. Assessment: This is an example of successful engagement as the company responded by proposing concrete measures. Future approach: We intend to monitor the progress of the revised plan and encourage the company to further accelerate its emissions reduction efforts, including where required through measures such CO2 capture and storage from 2030 onwards, which would require cooperation with players in other industries. Summary The climate change crisis we are witnessing presents both challenges and opportunities. Focusing on the latter from an investment perspective, in our view asset managers are in a position to help facilitate society's goals of reducing GHG emissions and decarbonising. An important way of meeting investors' needs for portfolios with a lower carbon footprint is through direct engagement with investee companies. Japan is currently a major GHG emitter but the country's ambitious plan to become carbon neutral by 2050 has made it necessary for companies to ramp up decarbonisation efforts. The intent is not in short supply as Japan has the highest number of companies that support the TCFD and they are increasing the quality of their data disclosures. We believe strategies focused on climate change-related initiatives in Japan are uniquely placed to help with the construction of a greener portfolio while assisting society as a whole in its decarbonisation efforts. Author: Masayuki Teraguchi, Head of Investment Technology Fund Management Department Funds operated by this manager: Nikko AM ARK Global Disruptive Innovation Fund, Nikko AM Global Share Fund   1 "July 2023 is set to be the hottest month on record", World Meteorological Organization, 27 July 2023 2 "2022 Share of Electricity from Renewable Energy Sources in Japan (Preliminary)", Institute for Sustainable Energy Policies, 26 April 2023 3 QUICK sustainability awareness survey, December 2021 4* Figures for reductions in GHG emissions and GHG intensity are target values that could become difficult to achieve due to the market environment, AUM, changes in companies' emissions or other such factors. The figures are target levels as of the time of portfolio construction and rebalancing. They do not constitute a guarantee that the figures will be constantly maintained within a certain range during the investment management period. * The above quantitative targets (GHG emissions to be no more than approximately 50% of the benchmark level, etc.) may be subject to change in the case of changes in the market environment, etc. Important disclaimer information Please note that much of the content which appears on this page is intended for the use of professional investors only.