Environmental, Social, and Governance (ESG) investing is a term that is often used interchangeably with sustainable investing and socially responsible investing. It began in the 1960s with investors excluding stocks or entire industries from their portfolios based on business activities such as tobacco production or involvement in the South African apartheid regime. Today, we see ESG investing growing exponentially, with many investors wanting to ensure that their portfolios are aligned with their belief system and contributing positively to people and the planet.
This growing awareness continues to put pressure on fund managers when considering which underlying funds or stocks to support.
Investors are increasingly applying thee non-financial factors as part of their selection process. However, they need to be cautious as simply supporting an investment product because it is branded “green” might not deliver their ultimate goal: return on investment.
There is no definitive taxonomy of ESG factors. ESG factors are often interlinked and clearly defining issues within the three categories can be challenging. The question, therefore, is: Do we really understand the implication of ESG investing?
Not fit for exclusion
The easiest form of ESG investing to understand and implement is based on exclusion: If a company is doing something at odds with your values and goals, exclude it from your portfolio. This might be an option in markets where investors are spoilt for choice but we do not have that luxury in South Africa. Asset managers worldwide are looking at two key bases of engagement with companies – engage to catalyse change or disinvest. Engaging to catalyse is recognised as the prudent method of approaching the problem and getting companies to shift towards sustainability.
Many South African resource companies are transitioning their environmental practices but may not be categorised as “green” yet. Excluding those whose progression may not be as advanced, as one would prefer would create portfolio over-concentration in a concentrated market. Additionally, it would remove the companies’ exposure to the engine of our economy – and we are, first, a commodity-exporting country. Our resources sector was responsible for most of the JSE equity returns during the pandemic.
People living in poverty are unlikely to be concerned about their country being net-zero emitters. Such conflicts are a reality of the UN’s 17 Sustainable Development Goals (SDGs).
For example, as the drive towards renewable energy gains momentum, (SDG 7) investments in oil and gas have dropped off, reducing our ability to react to supply crunches, due to the Russian-Ukraine conflict.
The subsequent rise in living costs and pressure on business margins have put various SDG goals at risk, mainly as the goals were set up to trigger an urgent call for action by 2030. These include SDG 1 – No poverty; SDG 2 – Zero hunger; SDG 3 – Good health and well-being and SDG 8 – Decent work and economic growth.
Two other issues to consider within the ESG conversation are the objectives of halving emissions by 2030 and the EU’s aim to be climate-neutral by 2050.
It is always essential to apply ESG principles to considered investment strategies. In doing so, one ensures that capital isn’t being drawn away from critical economic foundations that make for a functioning society where investing is worthwhile.
No standards, no impact
“Greenwashing” is the exploitative practice used to mislead investors into believing that an investment product or fund is environmentally friendly and worth investing in.
That problem is unlikely to disappear while the data and methods used to measure environmental and social impact remain fragmented and subjectively applied. Lacking globally and locally is a standard model of measurement required to ensure greenwashing is not taking place. This must include standardising the data and having a regulatory framework in place for inclusive capitalism that managers can navigate and operate within.
To be sure, noticeable gains have been made towards solving the challenges. However, in a South African management context, more work lies ahead for incumbents and regulatory bodies.
The risk is that investors expend a lot of energy and resources to allocate according to the tenets of ESG – Environmental, Social and Governance – often at the expense of managing other risks and opportunities, only to have their capital make little to no impact.
A responsible approach to ESG
Most South African asset managers are conscious of the risk posed to their returns by ESG deterioration. They work to integrate the factors into their investment and so the risk management processes have begun in earnest.
Arguably, the most effective way to do that in the current environment is through engagement with the management of their portfolio companies.
But even that approach is not free from complexity. What if the right thing for the environment means less return for shareholders? And will the latter be able to form a consensus around which issues matter to gain the leverage needed to effect change?
We believe direct engagement to be the most direct and pragmatic approach available to South African asset managers looking to catalyse legitimate ESG outcomes without taking on inappropriate risk.
An honest assessment
At PPS, most of our asset managers have been focused on engagement and motivating companies to start shifting. We routinely engage with the fund managers that are included in our multimanager investment strategies around the myriad issues of ESG.
We adhere to a process, where we rate our managers and ask them to do the same. We haven’t retired any manager based on a poor rating; our approach instead is to rather engage with them. As PPS, it is important and we need to understand if the manager is making progress concerning improvement, or if there are material risks the investment strategy is being exposed to.
More generally, the level of ESG integration for SA managers and traditional asset managers is generally basic. At this stage, we are not excluding managers based on ESG considerations, however ESG integration may not always be relevant to their process. For example, our SA hedge fund managers typically do not explicitly focus on this.
We have consequently engaged with managers with a high level of ESG integration but not yet included them in any strategy or run a strategy solely focused on this (a strategic initiative unique to PPS). We are, however, developing valuable insight by comparing deliberate ESG managers with those who have retrofitted their processes’ tenets.
We support our managers’ efforts to integrate ESG factors in their processes and hold their portfolio companies accountable in pursuit of sustainable outcomes.
ESG is a complex and evolving issue, but our focus remains steadfast: to help more South Africans prioritise investment for the lifestyle and retirement they deserve. As innovation drives us toward a more mature iteration of ESG, it will play an increasingly important role in achieving the goal.
As with any portfolio influenced by the market, ESG investing is not without risks but allows clients to invest with a little more of their heart than before. Incorporating ESG into their portfolio can achieve their desired return on investment, with the advantage of taking ethical considerations into account.
It is an exciting but complex time for the world of business, investments and investors.
* Sherlock is the executive head at PPS Wealth Advisory
** The views expressed do not necessarily reflect the views of IOL or its sister titles