By Piet van der Merwe, ESG research analyst at Momentum Asset Management
Investment managers have started to consider the environmental, social and governance (ESG) value chain as part of their advisory mandate, which is no longer simply a ‘nice to have’ or new tool in the business development marketing kit.
A company’s financial metrics provide a good indication of shorter-term performance and sustainability, but little insight in terms of how the company will survive in the longer term. This is especially pertinent if the subject being evaluated is a large company into which billions of rands of pensioners funds have been allocated.
An issue which needs to be investigated is the quality of leadership within the business. Do they fully understand their industry or the challenges facing them? Can they provide visionary leadership? Are they good managers or simply bureaucrats? Are their egos proving detrimental to shareholder interests? What kind of corporate culture and values do they foster in their organisation? The quality of leadership employed by stakeholders and how governance is structured is critical to an institution’s long-term prospects. In the words of Napoleon Bonaparte: “There is no such a thing as bad troops, only bad Colonels.”
Apart from governance, there are also matters relating to the social and environmental consequences of business operations which need to be considered. Is the business ultimately a force for sustainable development within the community in which it operates? These are critical issues which may give rise to correct (or incorrect, in some unfortunate cases) perceptions about businesses and the catalyst for positive change they actually are within society. Perceptions, however, especially negative ones, have the unfortunate habit of becoming reality in public discourse and this has a long-term effect on business operations and the bottom line, as well as the societies involved.
The investment community has, as a result, slowly started to incorporate this thinking by introducing investment portfolios and manager research aimed at integrating long-term sustainability objectives into their thinking. A clear distinction must, however, be made between sustainable investing and corporate social investment. Corporate social investment may, in some cases, provide only intangible returns, while sustainable investment must provide measured, competitive, and even superior, yields. To pensioners reliant on investment revenues for their retirement, the distinction is anything but academic.
Socially responsible investing (SRI) has, furthermore, been assisted within the investment mind-set through the introduction of a related reference within the amended Regulation 28 of the Pension Funds Act, Code for Responsible Investing in South Africa (CRISA) and FTSE/JSE Index listing clause requiring all top-40 listed and mid-cap companies to complete an annual ESG questionnaire. At an international level, investment managers and retirement funds (including Momentum Asset Management) have signed up for the United Nations Principles for Responsible Investment (UNPRI) code in an effort to promote the sustainable investments cause.
An ability to apply ESG criteria is, however, a skill which still needs to be honed in many investment management companies. It is sometimes very difficult to get beyond ‘sloganeering’ and noble intentions to actual implementation.
The ideal ESG specialist is someone who demonstrates a keen interest in related issues in tandem with an investment background. Translating targeted investment ESG ratings into a measurable quality rating then becomes the next step in developing an investment model which legitimately incorporates these considerations into a company’s overall ‘investability’ assessment. Clients investing in a particular stock selection then have the assurance that ESG factors have been formally evaluated and considered as part of capital allocation decisions.
The environmental, monetary and social costs associated with companies which do not incorporate ESG thinking into their business model are many and varied. There are many examples of extensive environmental damage around the world, and in South Africa. In a country such as ours, where there are high levels of income and skill disparities, organisations need to take cognisance of the consequences of these inequalities as they form part of the economic and social fabric in which businesses operate in South Africa. As investment professionals, we need to be part of the solution while remaining true to our calling of delivering long-term sustainable growth for those who entrust us with their money.