David Levinson, Senior Investment Analyst at Nedgroup Investments, discusses the responsible investment landscape among their local and international asset managers.
Nedgroup Investments will shortly be launching its report on responsible investment practices being applied across a wide range of asset managers who are collectively accountable for about R3.5 trillion of assets. The research was designed to establish some of the best practices being applied within the sphere of responsible investment (RI) and to share this across the industry. The goal is to raise awareness of RI within the asset management industry and among clients who trust that their money is invested in a sustainable way.
The sustainability agenda
There is growing impetus to reframe the purpose of companies in the private sector. Historically, it’s very much been about shareholder return and by reframing it, it’s more about people over profit. Businesses are starting to reposition themselves and their role in society and Covid-19 may very well expedite that.
RI is often referred to in relation to ESG (environmental, social and governance). If we focus on environment as an example, since the industrial revolution we’ve seen a noticeable rise in CO2 in the atmosphere, passing the 400 parts per million mark in 2016, which shows the impact that fossil fuels are having on the world. In terms of what this could mean for weather in South Africa, the coastal regions could warm in the vicinity of 2 degrees by 2050, the central region by 2.5 degrees and as we go further north, 3 degrees warming. This translates into less absolute annual rainfall, which is worrying if we consider that South Africa is one of the 30th driest countries in the world. This could have huge implications for our agricultural systems, our biodiversity, human migration and urbanisation trends, food security and most importantly, water security. If the world were to warm by 3 degrees, some economic models suggest the impact on GDP in several Sub Saharan African countries could be as much as -5%, and even -18% in extreme cases. This has a massive implication for businesses in South Africa and what our economy may look like from an industrial point of view.
Key findings of the review
In South Africa, the main pressure point for ESG adoption does not yet come from individual investors, but from institutional asset owners or allocators. Foreign asset managers are more likely to be signatories to the United Nations' Principles for Responsible Investment (UNPRI), with a higher level of expectancy from their client bases. Non-SA fund managers outperformed local managers when it came to the level of participation in the broader RI space. We believe this was due to the availability of institutions and forums and the current lack of similar bodies or asset manager collaboration in South Africa. Corporate governance is at the forefront of investment decisions and is utilized within managers’ risk frameworks by applying a corporate governance premium or discount to their share valuation. Despite a belief in the impact on a share price, there appears limited evidence of adoption of environmental and social factors in the investment process. Larger SA asset managers have greater capacity for ESG specialists and tend to outperform across the majority of our criteria.
There is a respectable level of subscription to third party ESG service providers. However, evidence suggests a low correlation among these global service providers and their ESG rating results. For this reason and others, most active fund managers prefer to place greater emphasis on their own internal ESG evaluations. ESG disclosure among South African large cap companies meets the global standard, however, there is a shortfall among mid and small cap companies. Asset managers are open to acknowledging their shortcomings and exploring a way forward. All managers were eager to receive feedback from this review and implement some/all of the recommended best practices.
The majority of fund managers indicated that environmental factors could have a high, or even material, impact on a share price, but did not necessarily translate into them incorporating environmental factors into their investment process. Similarly, the majority felt that social factors could have an effect on a share’s performance. As envisioned, the overwhelming response was that Governance factors had a material impact on share price.
Six pillars of responsible investing
The review analysed six pillars of RI. Firstly, commitment to responsible investing, such as having an RI policy document, who is responsible for RI internally, e.g. CEO or a junior member of staff, which indicates buy-in and commitment to the RI process. Secondly, integration of ESG factors into the investment decision-making process and to what degree analysts take ownership of the ESG factors. Thirdly, proxy voting participation in terms of how they are voting, are best governance codes and critical thought being applied in the review of board member re-election and remuneration policies? The fourth pillar is responsible ownership and the depth and quality of corporate engagement, which was weighted most heavily in the assessment with an emphasis of engagement. Pillar number five is ESG transparency and disclosure, which includes putting voting records in the public space, client communication regarding ESG topics, etc. The final pillar was participative support and presence in the broader RI community, which had the lowest weighting, but there was an overwhelming response to be involved in improving in terms of this pillar.
Focusing on the CEO
When it comes to analysing the composition of a CEO’s short-term and long-term incentives, we need to move beyond typical metrics such as headline earnings per share, return on equity, or shareholder return, and look to attribute greater weight to environmental and social factors. Such as targets that focus on the intensity of carbon and water, or energy efficiency across operations. locally. Social factors have taken on a bigger focus in the mining space where CEOs are measured in terms of health and safety measures and limiting fatalities. Shareholders are putting more pressure on companies in this regard, which is encouraging.
Nedgroup Investments will be introducing a RI landing page for each of its funds and asset managers that talks to their approach to ESG. In addition, you will be able to see the holdings in the fund and all the resolutions that the fund voted on for each of the companies as well as the rationale for each decision. This demonstrates the critical thinking behind each decision, such as the application of King IV, etc. Given that Nedgroup Investments’ global footprint incorporates more than US$270 billion in AUM, it’s sobering to see the say we can have in this agenda and are excited to build on what we’ve done this year.