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Environmental, social and governance (ESG) principles in investment are no longer seen as an issue raised by vocal minority groups but as an important factor in giving you long-term, sound returns on your investments, particularly your retirement savings.
Retirement fund members can expect to hear a lot more about ESG as the preservation of the Earth’s resources, the improvement of living and working conditions, and improved behaviour from the corporate world move to the top of the investment agenda.
Expectations of proper behaviour are no longer only on the agenda of small environmental and ethical pressure groups. ESG issues are now on the world stage, driven by a spiralling world population and concomitant pressures on resources.
And the move is now driven not only by ethical, social and environmental concerns for their own sake but by the need for institutional investors, such as retirement funds, to deliver long-term, sustainable investment returns for you.
According to United Nations projections, the world population will be between nine and 11 billion people by 2050, up from 6.9 billion last year and 2.6 billion in 1948.
Jon Duncan, the ESG analyst at Old Mutual Investment Group SA (Omigsa), told the Institute of Retirement Funds convention earlier this month that this ever-swelling population presents a multitude of problems, including an enormous growth in consumption, urban densification, poverty, inequality, conflict, unrest, disease and malnutrition across the world.
And all the while, ever-greater pressure will be placed on the Earth’s already threatened natural resources and ecosystems, which are critical for the functioning of the global economy.
Duncan says the sustainability spotlight has now swung onto the investment community, challenging it to think and act more responsibly through the integration of ESG issues in long-term ownership and investment decisions.
He says the challenge in financial terms is “how to live off the Earth’s interest rather than its capital” – for example, through renewable energy sources, waste recycling and efficient production.
“We have to meet the needs of the current generation without compromising the rights of future generations to meet their needs,” he says.
Duncan says responsible investing does not mean compromising sound, long-term returns for investors. It is also not about reducing the investment universe. It is about ensuring that investment choices are made responsibly.
Duncan says current science on sustainability “tells us we need to be mindful of the long-term impacts of our current growth path”.
He says that at global and local level, regulation now requires greater consideration of sustainability issues. For example, the consideration of ESG principles is required in terms of regulation 28 of the Pension Funds Act, which governs prudential investing for retirement funds.
The South Africa investment community has also responded with the voluntary Code for Responsible Investing in South Africa (Crisa) – see “Crisa principles” and “Investor code to be implemented early next year”, below.
Duncan says responsible investment should not be muddled up with socially responsible investment (SRI) and ethical investing, each of which has a role as an investment approach. He outlines the differences as follows:
* SRI is targeted investment with positive screening and is aimed at achieving social outcomes and sound financial returns. The investment universe is typically focused on investments that are aligned with the investor’s desired social outcomes, such as increased employment, affordable housing or socially transformative infrastructure.
* Ethical investment, which includes faith-based investing, is based on negative screening – in this instance, the investment universe is constrained by certain ethical criteria, such as not investing in the gaming or liquor industries.
Duncan says responsible investment will require changes to the decision-making activities of asset owners, asset consultants and investment managers.
The responsible investment thesis is largely focused on the belief that ESG analysis will enhance the understanding of a company’s competitive risks and opportunities, value potential and future performance.
Duncan says institutional investors such as retirement funds, life assurance companies and asset managers wanting to align themselves with the Crisa principles will need to make a public commitment to responsible investing through things such as policy statements and guideline documents.
He concedes that it is not an easy task.
On a practical level, he points out that the approaches to integrating ESG into investment and ownership decisions will vary according to asset class. This requires ESG information to be made available by investee companies in annual reports.
He says the new integrated reporting requirements of the corporate governance standards set in King III should support greater ESG transparency in listed companies.
He says for responsible investing to be successful at the asset manager level it will probably need to be driven initially by dedicated ESG professionals.
Duncan says approaches to responsible ownership include a publicly available proxy policy (for voting at company meetings or on company activities), the publication of voting records, and active engagement between investors and the companies in which they are investing.
He says research is beginning to show that applying responsible investment using ESG principles does not mean poor investment performance. A study released in August 2011 by global asset manager RCM (a subsidiary of Allianz Global Investors), which focused on listed equities for the period 2005 to 2010 using MSCI ESG rating methodology, showed that investing in companies that operate best-in-class ESG strategies did not detract from returns.
“The report by RCM indicated that even in extreme market conditions, performance was not negatively impacted. Out-performance was seen across the range of global sectors and geographies,” Duncan says.
Investor code to be implemented early next year
The Code for Responsible Investing in South Africa (Crisa) was launched in July and will come into effect on February 1 next year when investors are expected to start reporting on its application.
The code seeks, on a voluntary basis, to apply both local and internationally accepted principles for responsible investment based on the three pillars of corporate behaviour: that companies limit damage to the environment, contribute to the good of society and are run in an ethical way.
Crisa was compiled by various institutions including the Government Employees Pension Fund (GEPF) and its main asset manager, the Public Investment Corporation, the Institute of Directors, Principal Officers Association, and the financial services industry body, the Association for Savings & Investment SA.
Adrian Bertrand, the ESG manager at the GEPF, says the United Nations-backed Principles for Responsible Investment (PRI) was a result of a global collaborative investor network being established in partnership with the UN Environment Programme Finance Initiative and the Global Compact.
PRI was launched in New York in 2006. The GEPF was one of the founding signatories and it serves on the UN-backed PRI advisory council.
“PRI provides investors with a framework for integrating ESG issues into mainstream investment decision making and ownership processes,” Bertrand says.
He says although PRI and Crisa are voluntary and aspirational, they are grounded in the fiduciary duty of institutional investors and asset managers to act with due care and diligence in the investment of your savings.
There are currently 35 signatories to PRI in South Africa. The PRI South Africa Network was launched in 2009, and one of its first collaborative engagements was to advise the King Committee on the role of institutional investors in promoting sound corporate governance. This led to the formation of a committee that drew up Crisa, with the intention that it should be adopted by all institutional investors (both local and foreign) and that they apply Crisa to the extent that they invest in South African companies.
Bertrand says Crisa, which is scheduled to be implemented on a voluntary basis, is an integral part of the corporate governance framework in South Africa.
The Crisa principles
The Code for Responsible Investing in South Africa (Crisa) is based on five principles. An institutional investor should:
1. Incorporate considerations about sustainability, including environmental, social and corporate governance (ESG), into its investment strategies, analyses and activities “as part of the delivery of superior, risk-adjusted returns to the beneficiaries”.
The investor should ensure that its ESG policies are implemented and must establish processes to monitor compliance.
2. Implement a policy that demonstrates its acceptance of its ownership responsibilities in its investment arrangements and activities. The policy should include guidelines, such as the King III corporate governance guidelines and ESG principles, to ensure the sustainability of investments, mechanisms to call to account a company when concerns have been identified; and how to vote on different issues at the annual meetings of companies.
Where an investor outsources services to service providers such as asset managers, it must ensure that the mandate addresses concerns about sustainability.
3. Consider collaborating with other institutional investors, shareholders, service providers and regulators to promote Crisa and other codes and standards.
4. Identify potential conflicts of interest and proactively manage these conflicts if they occur.
5. Be transparent about the content of its ESG policies, and how it implements these policies and applies Crisa. Details should be disclosed regularly to the companies in which it invests and to the investment beneficiaries.
FSB to amend trustee guide
The Financial Services Board’s (FSB’s) guide for retirement fund trustees, PF130, is to be amended to bring it into line with the corporate governance requirements of the King III report, as well as a requirement that retirement fund investment policy statements must incorporate the principles of the Code for Responsible Investing in South Africa.
In confirming the changes to PF130, Jurgen Boyd, the FSB’s deputy executive in charge of retirement funds, says there is already an obligation in terms of the prudential investment requirements that retirement funds, “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”.