When you put money into an investment such as a unit trust fund, does it concern you that your money might be used to buy shares in companies of which you do not approve? Perhaps a company harms the environment, or perhaps it exploits its workers, with its top managers earning hundreds of times the income of its lowest employees. Perhaps it produces goods that are detrimental to a healthy society.

More and more people, particularly among the “millennial” generation, are “investors with a conscience”, with concerns such as these influencing the investments they choose. There is also mounting pressure on institutional investors, such as pension funds, to channel money into investments that are beneficial to society and the environment.

The past decade or so has seen a strong rise in “socially responsible investing” (SRI), and with it the emergence of investment practices that take into account a company’s effect on the environment, how it treats its employees, how responsible it is to the broader community in which it operates, how ethically it is governed, and its long-term sustainability.

In 2006, the United Nations’ Principles for Responsible Investment (PRI) were developed by an international group of institutional investors that realised the increasing relevance of environmental, social and governance (ESG) issues in investing. These principles bind signatories to incorporate ESG issues into their investment processes, seek disclosure on ESG issues in the companies in which they invest, and work together to promote ESG awareness.

In 2012, South Africa produced the Code for Responsible Investing in South Africa (Crisa), along much the same lines as the PRI, supported by many of the major players in the financial services industry (see below).

These developments – in conjunction with increased regulation – have resulted in many of the big corporations that dominate our lives reassessing how they govern themselves and how they interact with the world around them.

In theory, an asset manager investing your money may adhere to Crisa and support ESG principles. But to what extent would the manager actively select or reject companies according to ESG criteria? And what about your primary goal, which is to maximise your returns? Are ESG-focused companies a better investment than those focused on short-term profits, for example? It seems logical that the former would be more sustainable and profitable over the long term, but does research support this?

In a paper titled “Determining ESG signals in the South African equity market”, Tracy Brodziak and Leanne Micklewood of Old Mutual Investment Group say that although South African listed companies have comprehensive financial data, insightful ESG data is not widely available, nor is there a consistent reporting framework.

Brodziak and Micklewood looked at research conducted by Credit Suisse bank in the Australian share market. It showed that “strong management of environmental issues ‘pays’ and weak management of environmental issues ‘costs’ at the portfolio level”.

Governance analysis revealed similar results, Brodziak and Micklewood say, while social data showed “that companies that have overall the weakest management capabilities and highest exposure to social issues significantly underperform all other companies”.

The research found that poor social performance ‘costs’ at the portfolio level. However, the converse did not hold: “There was no benefit from a strong social score at the portfolio level.”

Using limited ESG data (for only four years), the pair conducted similar research on South African companies. “While the timeframe is still too short to see definitive trends, the results appear to mirror those of international findings,” they say.

Brodziak and Micklewood say that, in years to come, as data increases and they are in a position to assess ESG factors through different investment cycles, their goal is to develop a higher level of confidence in ESG signals in the investment process.

“This aligns with our view that sustainability is reshaping the competitive landscape, and that companies that are able to respond to this trend and innovate early will reap the benefits of stronger growth prospects, enhanced operating efficiencies, a stronger social licence to operate, enhanced staff retention, lower cost of capital and, ultimately, a stronger and longer competitive advantage.”

Terence Craig, the chief investment officer of Element Investment Managers, a pioneer of SRI in South Africa, provides further evidence of the advantages for investors. He says: “The reality is that ensuring companies focus on material ESG issues can drive greater returns for investors, as is highlighted in a number of research papers.

“According to a March 2015 study by Harvard Business School, covering the 20 years from 1992 to 2012, using the materiality framework of the Sustainability Accounting Standards Board, companies that address material ESG issues and ignore immaterial ones outperform those that address both material and immaterial issues by four percent a year and outperform companies that address neither by nearly nine percent a year. Clearly, investors do not need to compromise investment returns as responsible investors.

“An irony is that South Africa faced the full effect of shareholder activism focusing on social issues in the late 1970s and 1980s. Investors were instrumental in forcing American companies to pull out of South Africa and not do business with an apartheid state. Ultimately, this pressure contributed to long-term fundamental change for the better in our country,” Craig says.


CRISA – THE BASIC PRINCIPLES

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 beneficiaries.

2.   An institutional investor should demonstrate its acceptance of ownership responsibilities in its investment arrangements and activities. (This refers to an institutional investor’s responsibilities as a shareholder.)

3. Where appropriate, institutional investors should consider a collaborative approach to promote acceptance and implementation of the principles of Crisa.

4. An institutional investor should recognise the circumstances and relationships that hold a potential for conflicts of interest and should pro-actively manage these when they occur.

5. Institutional investors should be transparent about the content of their policies, how the policies are implemented and how Crisa is applied to enable stakeholders to make informed assessments.

martin.hesse@inl.co.za