Applying ESG can mitigate SA stock market concentration risk
With several companies announcing their intention to delist from the JSE in 2020, many South African investors may feel that they have a limited investment universe when considering local stocks.
While this may be true, Gontse Tsatsi, Head of Retail Distribution at Old Mutual Investment Group, says this shouldn’t hinder but reinforce the case for pursuing a local environmental, social and governance (ESG) strategy. “Incorporating ESG factors can partly mitigate the concentration risk of investing in a limited universe of companies,” he says.
According to Tsatsi, ESG measures are indicators of an organisation’s overall resilience and long-term sustainability, and according to Merrill Lynch, the single best signal of future investment risk. “According to research, had an investor factored ESG into their long-term investment decisions starting in 2008 they would have avoided 90% of corporate bankruptcies in the United States between 2008 and 2017,” says Tsatsi.
He says that key metrics include not only environmental and social responsibility but also company gearing and transparency. “ESG scores are a proxy for high quality and well-managed companies, and those that score high are usually long-term players as opposed to being focused on short-term gains,” he says.
Tsatsi says by applying an ESG lens to the local equity market like the JSE, investors can position their portfolio for long term sustainable growth. “Companies with higher ESG scores show lower rates of share price volatility, lower cost of capital, stronger resource efficiency, stronger social licence and better labour relations, which all translate into improved performance and ultimately better returns,” he says.
South African investors who wish to build or adjust their portfolios to have a stronger ESG bias have several options open to them.
He says that the first option is to consider investing in a local, actively managed ESG equity fund. “A fund that targets a 40% lower carbon footprint and a 20% higher ESG profile relative to the benchmark, like the Capped SWIX index is a good option,” says Tstasi.
Another alternative is to consider a shari’ah compliant equity fund with an ESG overly. “These funds are prohibited under Islamic finance laws from investing in companies who raise revenue through the sale of interest-bearing products or alcohol, tobacco, gambling, and arms manufacturing,” says Tsatsi.
“By applying an ESG overlay to the remaining universe of investable assets, these funds only invest in good quality companies with low gearing (low debt ratio), which is another feature of Islamic finance.”
One of the often-overlooked benefits of adopting an ESG investment philosophy, he adds, is that Old Mutual Investment Group can play a more influential role as a steward of good business practices.
These processes, much like investing, require a long-term approach to achieving the best outcomes for all South Africans, investors and broader society alike, concludes Tsatsi.