Responsible Investing - the big questions

By David Levinson

With around R240 billion assets under management, Nedgroup Investments acknowledges the far-reaching implications of how we invest. Over the past twelve months the continuation and growth of our Responsible Investment (RI) drive has been a focus for us as it becomes increasingly synonymous with the strategic direction of the overall business.

In this the first article in our series of updates on RI at Nedgroup Investments, it is important to distinguish RI from Corporate Social Investment (CSI) and Social Impact Investing. These terms can often be used interchangeably which can create some ambiguity and confusion.

What is RI actually?

Significantly, RI does not translate into sacrificed returns in the pursuit of environmentally- or socially-focused investments. Rather, we believe that companies incorporating best environmental, social, and governance (ESG) practices will yield superior financial returns in the long-run. In fact, it is the inclusion of these non-financial factors into traditional analysis that enables us to holistically manage risk and achieve sustainable returns.

We believe ESG data serves as an enabler for deeper and more constructive engagement with the companies that we invest in. In our view, it is the companies who embrace sustainability that will show outperformance over the long-term, and thus better align themselves with the investment horizons of our fund offerings.

Deutsche Bank, in conjunction with the University of Hamburg, recently reported on the correlation between ESG and corporate financial performance across several key regions. The results charted below highlight the significance of ESG within emerging markets such as South Africa.

A global trend

There is a growing appetite across the globe for ESG-related investment products. According to Morningstar, U.S.-domiciled sustainable investment ETFs attracted nearly USD 5.5 billion in net flows during 2018. It was the third straight year of record annual net flows and starkly contrasts with the overall U.S. fund universe. Larry Fink, BlackRock’s CEO, recently forecast AUM in the ESG category to grow from the current USD 25 billion to USD 400 billion by 2028 (a 32% compound annual growth rate).

These trends capture the rising demand for such investment products but can also be attributable to national regulations and codes that look to steer assets towards RI-centred investments. These include the Stewardship Code (UK), Article 173 (France), the Corporate Governance Principles and Recommendations (Australia), and the UN Global Compact. McKinsey, a global consultant, believe that more than a quarter of the USD 88 trillion assets under management globally are now invested according to such ESG principles. 

Where does South Africa fit in?

Locally, RI is in its relative infancy, but the approach is undoubtedly gathering steam. Since the inclusion of ESG into Regulation 28 of the Pension Funds Act, we have seen the proliferation of the Codes for Responsible Investing in SA (CRISA), the United Nations Principles for Responsible Investing (UNPRI), and the King Codes on Corporate Governance. Below we provide a few notable extracts that allude to ESG integration:

Regulation 28 of the Pension Funds Act:

“Prudent investing should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance character. This concept applies across all assets and categories of assets and should promote the interests of a fund in a stable and transparent environment.”
Furthermore, “A fund and its board must… before making an investment in and while invested in an asset, consider any factor which may materially affect the sustainable long-term performance of the asset including, but not limited to, those of an environmental, social and governance character.”

Codes for Responsible Investing in South Africa:

“Principle 1: An institutional investor should incorporate sustainability considerations, including ESG, into its investment analysis and investment activities as part of the delivery of superior risk-adjusted returns to the ultimate beneficiaries.”

Balancing the act – can we apply RI in a local context?

On the surface these principles appear applicable enough, but in practice they force SA investors to ask some difficult questions.

To elaborate - a school of global managers and pension funds have taken the hard-line of excluding fossil fuels, tobacco, alcohol, and military-linked stocks from their investable universe. However, given the concentrated nature of South Africa’s listed exchange, many opinions are that this approach is neither pragmatic nor effective in a local context. And, arguably, will not lead to real positive change.

This poses an interesting conundrum for South African investors, with the likes of British American Tobacco and AB InBev often playing important strategic roles within a portfolio. An alternative view to ‘stock exclusion’ is to maintain one’s investment and through measured shareholder activism, guide investee companies to follow best corporate and sustainability practice. We believe this practical approach is where the greatest impact can be made.

Given South Africa’s rich natural resources, the balancing act between environmental and social concerns is more precarious here than most. Take Sasol as an example. With annual SA emissions of around 60 million tons of carbon dioxide-equivalent, this would place them as the single largest greenhouse gas emitter on the JSE. In fact, during a normalised year, this would equate to around 12 percent of South Africa’s total emissions. Sasol on the other hand employ around thirty thousand people with multiple dependents, and thus serve an important role in an economy characteristic of chronically high unemployment and social inequity.

A similar question arises with British American Tobacco. According to the World Health Organisation, tobacco kills six million people per year[1], but the company’s value chain provides the livelihood for tens of thousands of rural farmers across the developing world.

These two examples illustrate the complexity that comes with being a responsible investor - the answers are not always clear, and the problems seldom yield perfect solutions.

The role shareholders can play

Recent events at the likes of Steinhoff and Resilient have given ammunition to the argument for stringent governance and independent oversight. Shareholders cannot underestimate their role in championing corporate governance, encouraging companies to better mitigate their environmental footprints, or ensuring that social risks are managed in a fair and just manner. Responsible investing does not merely serve to satisfy a moral stance but is an important tool in the pursuit of long-term performance.