A better way forward
ESG
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According to Morningstar figures, more than $2tn is now invested in ESG strategies around the world. In the first quarter of 2021 alone, total assets in this sector rose 19%. This does not look like a cyclical shift. As Old Mutual Investment Group’s Jon Duncan put it recently: this is a permanent reallocation of capital. With this comes the fact that the investment industry is having to embrace the idea that old models for evaluating assets are no longer sufficient. ‘Previously it was just about risk and return,’ Duncan said. ‘Now it is risk, return and impact. The efficient frontier is no longer a two-dimensional thing.’ In this special Citywire ESG supplement, we explore how local fund selectors are increasingly demanding more from asset managers when it comes to sustainable and responsible investing. We also look at the big shifts that have taken place in ESG investing around the world. And finally, we examine whether South African asset managers are making the most of their collective influence. In a post-Covid world, these are increasingly the questions of our time. Finding the right answers is imperative to charting a better way forward.
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content by: oLD MUTUAL INVESTMENT GROUP
chapter two
South African DFMs have been forced to reassess their due diligence process after one of the biggest governance scandals in recent history
CHAPTER ONE
Sustainable investing has changed significantly in a short period of time. We highlight the key aspects of ESG's evolution
Luke Barrs explains Goldman Sachs' approach to ESG investing and what makes the firm's proposition unique
Content by: Goldman sachs asset management
CONTENTS:
patrick cairns
editor, citywire south africa
This year's COP26 summit may spark a wave of neto-zero legislative targets. T Rowe Price highlights what needs to be done
content by: t. rowe price
chapter three
Asset managers will need to come together to solve the environmental problems facing the world
Changing for good
content by: OLD MUTUAL UNIT TRUSTS
In the past decade and a half, there has been a monumental shift in attitudes and applications in the ESG space. Fifteen years ago, sustainable investment opportunities and specialists were few and far between. ESG was nice to have, but didn’t require much attention. Return expectations also weren’t very high. All of that has changed. Investor demands are high, long-term returns haven’t been compromised, and there has been rapid growth in the number of ESG funds and investment specialists. This shift in attitudes and applications has taken shape in five key ways. Evolution one: ESG is now a core investment function In 2015, Goldman Sachs Asset Management acquired Imprint Capital Advisors, a specialist ESG and impact investing firm. Claire Hedley was part of the Goldman Sachs team and started working with the Imprint team on ESG shortly after the acquisition. ESG wasn’t her full time focus. Now it is. Hedley’s ESG journey reflects the evolution: ESG has moved out of the side seats onto the main floor. ‘ESG was something that was on the periphery of the investment process,’ she said. ‘Maybe there was one person, or a small team focused on ESG, and they didn’t have much weight in the investment decision making process. Now, ESG is a core function integrated into broader investment functions like asset allocation and risk management.’ Hedley is Goldman Sachs Asset Management’s ESG and sustainable investing strategist for Europe, the Middle East and Africa. Evolution two: E and S are dominant The emergence of a dominant E is a major theme and trend in ESG. ‘The significant impact of climate and environmental changes across the globe has become increasingly apparent,’ said David Zahn, head of European and sustainable fixed income for Franklin Templeton Fixed Income. ‘As a result we have seen an increase in demand for investments from clients that can help fund projects with positive environmental and/or climate benefits. ‘Given the emphasis in the EU on climate change and pledges to decarbonise the economy, climate change will definitely be the focus for the next few years.’ S emerged as an equally dominant theme in 2020 with social issues such as diversity, racial and gender equality, inclusion, inclusive growth and a living wage gaining prominence. Hedley uses the analogy of ESG in a car – E was always in the driver’s seat, in 2020 S was catapulted from the back seat to the front seat, next to E.
words by Patricia Holburn
The five stages of ESG evolution
chapter one
If companies have a plan to start changing, that’s where you can have an impact as an investor and also generate alpha
Evolution three: Engagement to drive change ‘Divestment may be a logical approach to ESG,’ said Andy Howard, Schroders global head of sustainable investment, ‘but it is not an effective way to drive real change. We believe a more effective way to drive positive change is to actively engage with companies individually or collectively to improve existing practices and ensure management teams are adapting their business models in the long-term interests of all stakeholders.’ Howard said engagement can range from a relatively light touch – for example providing feedback on a company’s code of conduct – to very involved – such as pushing companies to set strategic plans aligned to net-zero carbon emissions. ‘We don’t say we’re going to buy best-in-class in everything. We rule out the very bottom of worst-in-class, but what we’re really looking for are companies and or countries that have acknowledged an issue with one part of the E or S – not usually the G – because if you don’t have governance, the others don’t work,’ Zahn said. ‘The key is, if companies actually have a plan to start changing that. I think that’s where you can have an impact as an investor, but also, you can generate alpha.’ Evolution four: Complexity on the rise ESG is becoming more complex. There are more critical issues to focus on, increased regulation and the many new investment opportunities can be difficult to evaluate. ‘More than 120 new or revised policy instruments with a sustainability focus were established in 2020 – the highest number ever recorded – and over 30% more than in 2019, according to the Principles for Responsible Investment,’ Howard said. This alone would make ESG investing more complicated. Add in the need to evaluate so many different approaches to ESG and new investment opportunities, and ESG becomes a job for the specialist. Hedley uses the example of clean energy investments that may target net-zero carbon emissions or Paris alignment or other ambitious climate goals. ‘Investors will need to think about different approaches companies take and make sure they find the right entry point – and meet risk-return targets. These are complex decisions and will require a degree of specialisation,’ she said. Evolution five: More demand, more funds, more flows ‘Based on the results of our annual Global Investor and Institutional Investor studies, we can confidently say that investor demand for sustainable investing is strong,’ Howard said. Morningstar data showed record inflows of $185.3bn into 4,524 global sustainable funds in the first quarter of 2021, an increase of 17% over the previous quarter. 169 new funds were launched. Add that to 2020’s 532 new funds and that’s 701 funds launched in the last 15 months. Not bad for what was once a nice to have. But still small in the +120 000 mutual fund universe.
ESG Investing is Here to Stay
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A Q&A with Luke Barrs, Head of Goldman Sachs Asset Management Fundamental Equity Client Portfolio Management in EMEA Why should investors care about ESG? I think it comes down to a simple idea: companies that create value for all their stakeholders—customers, suppliers, employees, society at large—have a better chance of delivering strong and consistent returns for investors. There’s no doubt that companies are under pressure from shareholders, employees, consumers and governments to fight climate change and promote sustainability. We think those that haven’t yet embraced Environmental, Social and Governance (ESG) considerations will need to change in order to survive—and fast. Tech companies are leading the way here; many of the Big Tech names, for example, already use renewables for powering their servers. We believe that pressure from governments, consumers and investors will be key in driving companies to innovate and create new products and services to help deliver positive environmental change. And we need that change, because we are facing a climate emergency. Signs are everywhere: pollution, wildfires, hurricanes, floods. Fortunately, the world is waking up to this fact, and we believe we are on the cusp of a sustainability revolution that will help the planet change course. At Goldman Sachs Asset Management, we are committed to the sustainability of our planet, our society and our economic growth. Each day, we help our clients invest across asset classes, sectors and regions through a variety of funds and strategies. Many incorporate ESG factors, which we believe are central to a traditional evaluation of risk and return. How does the Fundamental Equity team at Goldman Sachs Asset Management incorporate ESG into the investment process? Sustainability is ingrained in how we invest - we consider robust ESG analysis throughout our approach. It helps us form comprehensive views about company performance and make better, more informed investment decisions. We analyse ESG issues along with the company fundamentals and we include the ESG view as part of our overall evaluation of how attractive an investment that company is. We certainly don’t believe there’s a trade-off between ESG factors and portfolio returns. In fact, integrating ESG considerations and analysis into our process often helps us uncover underappreciated information about particular stocks, which can make it easier to protect portfolios against downside risk. In other words, integrating ESG factors into our bottom-up fundamental investment process is a valuable way to identify key risk and return drivers for our investments. This is why we believe that ESG should be entrenched in the investment process rather than an overlay or a simple box-ticking exercise. How do you measure companies’ commitment to ESG? ESG assessment requires a deep understanding of a company’s working practices, operations and ecosystem. As an active manager, we take this responsibility seriously, and we use all the tools available to us to develop that understanding so we can make informed decisions for investors. While we leverage resources of third-party data providers to help form our own assessments, we fully acknowledge that third party ESG data is by no means perfect and comes with certain challenges, ranging from lack of data to flawed estimates. That’s why we think active engagement with corporate leaders is so important. Led by the Goldman Sachs Asset Management Stewardship team, we conduct more than 10,000 company meetings a year, which amongst other issues, can help to determine whether management teams recognize relevant ESG risks and opportunities and respond accordingly. Our focus on engagement with management further ensures that incomplete disclosure of ESG data does not necessarily impede our ability to make a thorough assessment of a company’s ESG credentials. This approach facilitates asking the relevant questions about a company’s approach to sustainability—and getting the right answers—while also avoiding the pitfall of relying on second-hand and incomplete data. A critical tool is our ability to promote improvement on ESG issues through proxy voting, and potentially encouraging positive changes in corporate behaviour. We believe companies that are committed to improvement will produce better risk-adjusted returns for investors. To put it another way, we think there’s a connection in doing good and doing well. What makes your approach to ESG unique? We believe that a valid assessment of a company’s ESG credentials and commitment to sustainability has to reflect an understanding of the specific risks and challenges to that business and the industry in which it operates. This is why we assess and weigh ESG factors differently in different sectors. In our view, there are no “one size fits all” solutions when it comes to ESG investing. Another differentiating factor is how we apply this approach within thematic investing, specifically the close attention we pay to Millennial consumers—the most powerful and influential consumers in the world. Why does this matter? Because Millennials care about ESG and having a positive impact on the world they live in, and they tend to favour sustainable goods and products. The Goldman Sachs Global Millennials Equity Portfolio offers a thoughtful way of gaining exposure to this Millennial Effect, with a heavy concentration in stocks from companies that consider sustainability factors as an active part of their decision making. The portfolio has zero exposure to the energy sector or “dirty” materials and instead focuses on companies that we believe will be at the forefront of delivering sustainable solutions across industries while offering investors quality and compelling valuation. For more insights on ESG visit our ESG Funds Centre.
Disclosures This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. This material has been prepared by GSAM and is not financial research nor a product of Goldman Sachs Global Investment Research (GIR). It was not prepared in compliance with applicable provisions of law designed to promote the independence of financial analysis and is not subject to a prohibition on trading following the distribution of financial research. The views and opinions expressed may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates or changes. Environmental, Social, and Governance (“ESG”) strategies may take risks or eliminate exposures found in other strategies or broad market benchmarks that may cause performance to diverge from the performance of these other strategies or market benchmarks. ESG strategies will be subject to the risks associated with their underlying investments’ asset classes. Further, the demand within certain markets or sectors that an ESG strategy targets may not develop as forecasted or may develop more slowly than anticipated. THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO. Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant. This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice. United Kingdom: In the United Kingdom, this material is a financial promotion and has been approved by Goldman Sachs Asset Management International, which is authorized and regulated in the United Kingdom by the Financial Conduct Authority. South Africa: Goldman Sachs Asset Management International is authorised by the Financial Services Board of South Africa as a financial services provider. This material is not intended and does not constitute an offer, invitation, or solicitation by any person to members of the public to invest or acquire shares in any fund referenced in the material and is not an offer in terms of Chapter 4 of the Companies Act, 2008. Any fund referenced in this material could be classed as a foreign collective investment scheme as contemplated by section 65 of the Collective Investment Schemes Control Act, 2002 and is not approved in terms of that Act. © 2021 Goldman Sachs. All rights reserved. 242908-OTU-1422923
Morningstar Global Sustainable Fund Flows - Q2 2020
A forward-looking ESG momentum strategy focused on the improvements of material ESG factors at an industry level appears to be a promising approach to create alpha
Luke Barrs Head of Goldman Sachs Asset Management Fundamental Equity Client Portfolio Management in EMEA
Local DFMs and multi-managers are asking asset managers much harder questions about their process Multi-managers are placing a sharper focus on ESG following recent debacles such as what took place at Steinhoff. Chad Ward, head of manager research for Riscura SA, believes the real understanding of ESG comes from engagement with managers and understanding the practical processes they use. ‘Looking at case studies gives us real insight in terms of how the fund manager’s process is meant to work, and how it actually is working,’ he said. Ward said that aside from the fraudulent accounting, there were several governance issues at Steinhoff. ‘Although it happened some time ago, we took a backward look with fund managers, asking them the tough questions. And in hindsight, we have had a more detailed conversation. We went through a massive drive with local asset managers, as Steinhoff was happening and post-Steinhoff, to understand their thinking. ‘Are managers scrutinising the board structures sufficiently rather than operating from a position of trust? What we have seen across the industry is that Steinhoff was a big turning point in South Africa, where ESG issues suddenly became very real,’ he said. Selection, appointment and monitoring Florbela Yates, head of investment consulting at Momentum Investment Consulting (MIC), said ESG criteria form part of MIC’s investment management selection, appointment and monitoring process. ‘When our manager research team and portfolio managers engage with an investment manager, we have a set of questions that we include in the due diligence that specifically addresses the ESG factors. These help us to determine whether ESG forms part of their process, how competent they are in this area and how integrated the views are in their process,’ she said. MIC’s ESG questions cover various factors such as: • Insights into their organisation: Are they signatories to the UN-supported Principles for Responsible Investment (PRI)? Do they support and endorse the Code for Responsible Investing in South Africa? Do they disclose their responsible investing policy on their website? • Investment management resources: This is about understanding the level of expertise required to interpret how ESG risks translate into investment decision making and outcomes. This expertise may be outsourced to research companies specialising in ESG analysis or may be found internally. • ESG integration: To what extent do investment managers integrate ESG across their investment process? Yates said the key point is the extent of ESG integration rather than the type being implemented. • Active ownership: This is about understanding the extent to which the investment manager contributes to a well-balanced economy for investors. These questions assess to what degree the fiduciary’s formal rights are used to influence the activity and behaviour of invested companies.
words by Neesa Moodley
Multi-manager lens on ESG sharpens after Steinhoff debacle
Steinhoff was a big turning point in South Africa, where ESG issues suddenly became very real
Reporting Yates said MIC expects fund managers to report any material ESG matters as they arise, or at minimum on a quarterly basis. ‘Through our investment manager rating process, we request a range of written evidence to illustrate the investment manager’s responsible investment approach.’ Jennifer Henry, head of strategic investments and manager research at Stanlib Multi-Manager, said the firm incorporates ESG in its due diligence process when evaluating whether a manager should be a buy, hold or sell. ‘We don’t believe in a tick-box approach, but rather critically assess all information that is presented, whether that is qualitative information or what we pick up from fund manager presentations so that we have a holistic view,’ she said. Different approaches Henry says Stanlib Multi-Manager’s ESG questions start off at a fairly high level and then dig deeper into the nuances of ESG incorporation. ‘Our due diligence includes a lot of free text, and we realised that there are very different approaches to ESG out there. For example, the ESG responsibility might fall to a portfolio manager at a smaller fund manager, while at a larger fund manager, the ESG responsibility and engagement with underlying companies would be the responsibility of the analyst. ‘At even bigger managers, you can expect to find an entire ESG dedicated team. So, there is a spectrum of approaches to how the ESG analysis is integrated at manager level,’ she said. She says Stanlib Multi-Manager has also seen the use of external ESG data. However, in the companies under its coverage, external data is used in addition to the managers’ own internal analysis and not as a stand-alone resource. South Africa still lagging on ESG focus Despite this focus from DFMs and multi-managers, South African asset managers seem to be behind global attitudes around ESG. The Macquarie Infrastructure and Real Assets Report ESG Survey 2019, which covered 150 real asset investors responsible for managing more than $20tn of investments globally, found that 58% of respondents had increased their ESG focus during the previous five years, and 91% expected it to increase further in the next five years. However, a survey by MIC of 41 South African asset managers last year showed that only 22 were PRI signatories. Yates said 29% rated below a level that MIC would consider aligned to a responsible investment culture, while 10% had no responsible investment policy in place at all. Of the 41 asset managers included in the survey, 10 were large established players with a link to an insurance company, a bank or a financial institution. Seven were large boutiques with assets under management of more than R50bn and 24 were smaller owner-based boutiques with assets under R50bn.
Why 2021 Could Be an Epic Year for Climate Regulation
The impact of climate change presents a systemic investment risk, making the importance of an investment’s environmental footprint more critical than ever before. The world has already experienced a rise of around 1°C in global temperatures over the preindustrial period and has started seeing the impacts of climate change in the form of extraordinary weather events, shrinking glaciers, and changing rainfall patterns. To be successful in limiting the adverse impacts of climate change, a fundamental shift is needed in the relationship between the economy and the environment. While financial markets are well positioned to play a leading role, ultimately they will only be effective if climate change regulation is in place. Over the past year, we have seen strong momentum to close that gap—a trend we expect to continue through 2021 as we lead up to the 26th United Nations Climate Change Conference (COP 26) in Glasgow in November. Net zero carbon emissions targets (net zero targets) have been established by 61% of countries, 9% of states and regions in the largest emitting countries, and 13% of cities with a population of over half a million. In aggregate, they account for just over 60% of the world’s carbon emissions. [1] A focus of COP 26 will be securing greater adoption of net zero targets—more countries have signaled that they will make announcements in the lead-up to the conference.
[1] Taking Stock: A Global Assessment of Net Zero Targets, Energy and Climate Intelligence Unit (March 2021). Net zero means achieving a balance between the greenhouse gases put into the atmosphere and those taken out. This state is also referred to as carbon neutral. [2] Source: The International Energy Agency (IEA). As of December 2020. [3], [4] Liu & Raftery, Country-based rate of emissions reduction should increase by 80% beyond nationally determined contributions to meet the 2°C target (Nature 2021). Important Information This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested. The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction. Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price. The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction. South Africa—T. Rowe Price International Ltd (“TRPIL”) is an authorised financial services provider under the Financial Advisory and Intermediary Services Act, 2002 (FSP Licence Number 31935), authorised to provide “intermediary services” to South African investors. © 2021 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/ or apart, trademarks of T. Rowe Price Group, Inc. 1661863 2021/05
Except for a handful of countries, direct legislation to underpin net zero targets is largely absent however, it appears that the urgency of the situation is increasingly understood. Simply put, the odds of meaningful climate regulation coming into force is very high. Carbon dioxide (CO2) makes up about three-quarters of greenhouse gas emissions and is one of the more readily available environmental statistics. As such, it receives the most attention when it comes to climate change analysis. However, staying within a global temperature rise of 1.5°C will require mitigating more than just CO2. In addition to regulation focused on power generation, energy efficiency and transportation, the task will require comprehensive regulation to mitigate methane (CH4), nitrous oxide (N2O), and fluorinated gases, as well as more sustainable land use and enhancement of carbon sinks. To date, most of the world’s climate regulation has focused on carbon—mostly within the power sector—but that is changing. To put the potential impact of forthcoming regulation into perspective, most estimates indicate that the world’s current climate change commitments put us on a path to 2.7°–3.0°C of global warming. This is based on climate commitments made through the nationally determined contributions (NDCs) submitted by signatories of the Paris Agreement in 2015. Using a statistically based probabilistic framework, the probability of staying below 2°C warming is only 5% assuming a continuation of current trends. [3] If all countries were to meet their NDCs, it rises to 26%. [4] These low probabilities underpin the importance for net zero commitments. How Climate Change Affects Financial Performance While markets have anticipated some climate legislation coming into force, namely in select sectors directly impacted by energy transition, we do not see widespread evidence of dislocation in valuations across the broader economy. As new rules come into effect around the world, we expect that performance around climate issues will become increasingly more important to investment performance. Interestingly, we see a bifurcation in corporate approaches to climate change across all sectors of the economy. As legislative initiatives start to directly impact financial performance, we believe the differentiation between winners and losers will become evident (and potentially quite quickly). Of course, regulation is not the only factor moving the needle on how issuers are responding to climate change. Other important factors are innovation and consumer preferences. On the innovation front, new advances have driven down costs in renewable power, which has sped up deployment of renewable capacity. The International Renewable Energy Agency estimates that the 3.2 terawatts implied in current NDC power targets for 2030 should be met as soon as 2022. On the consumer preferences front, we see companies adding environmental labeling to products as well as increasing demand for more sustainable products such as meat alternatives. Evaluating Climate Change in Investments At T. Rowe Price, our central mission is to help our clients reach their long term financial goals. Consistent with that objective, we have an obligation to understand the long-term sustainability of the companies in which we invest – which is why environmental, social and governance (ESG) factors are a key consideration in our investment approach. We systematically evaluate climate change factors for individual securities and portfolios with our proprietary Responsible Investing Indicator Model (RIIM). RIIM analysis provides two key benefits for our analysts and portfolio managers. First, RIIM proactively searches for environmental indicators and controversies on companies and sovereign issuers— this is an important feature as environmental data is not required disclosure nor is it standardized like financial data. Second, RIIM provides a framework for evaluating environmental factors—in essence it creates a common language for our analysts and portfolio managers to discuss how an investment is performing on environmental factors as well as compare securities within the investment universe. Our evaluation of climate change factors focuses on energy transition and physical risk, but we also believe that an issuer’s environmental footprint and track record are important indicators of how they may perform in a tightening regulatory environment. Climate change is increasingly a major concern for global communities, companies, and investors. The focus on how companies are working to mitigate the risks to their activities is only set to intensify, and COP 26 and regulatory efforts will bring the issue further into the spotlight. For our part, we are committed to ensuring that climate-relevant data are a feature of our investment analysis and decision-making. For further information, please visit www.troweprice.com/esg
Is a greater focus on collaboration evolving in the local asset management industry? Over the past few years there has been a meaningful shift in attitudes towards ESG in South Africa. Some devastating corporate governance failures and a growing awareness amongst asset owners of ESG imperatives has pushed both asset managers and listed companies to take these issues far more seriously. ‘Three or four years ago we would ask a big, local-listed company ESG-related questions, and they would tell us we were the first asset manager to ask them about these things,’ said Asief Mohamed, chief investment office at Aeon Investment Management, one of the local industry’s ESG pioneers. ‘I remember asking the chairman of a big local retailer what they are doing to increase the number of small suppliers in their supply chain, and he told me to ask the head of corporate social responsibility. ‘Things have evolved. Now, when you attend company presentations, the first slide is usually about ESG.’ Rands and cents In Mohamed’s view, this is largely because the economics of it have become increasingly apparent. ‘More businesses and asset managers are realising that ESG can be net present value positive,’ he said. ‘So, now they are on the bandwagon of ESG, otherwise they wouldn’t be. The rands and cents are dragging them along.’ There is no question that more asset managers are seeing ESG as a part of their research process, to varying degrees. More firms are asking for better disclosures from listed companies. However, even on some of the biggest ESG questions, asset managers don’t always seem to be pulling in the same direction.
words by Patrick Cairns
Nobody can solve ESG on their own
Collaborating on ESG is reflective of a much bigger shift in the global governance arena
Collaboration ‘Collaboration is not something that is native to this industry,’ said Jon Duncan, head of responsible investing at Old Mutual Investment Group. ‘My own experience working in the field of sustainability is that it was always abundantly obvious in that space that if you are trying to solve a water crisis or groundwater pollution or anything of that nature you need multiple stakeholders to be involved. That industry was naturally collaborative on the resolution of issues, but because of the competitive nature of the investment industry, that wasn’t what I first experienced here. ‘But I do think that is changing. Old Mutual Investment Group is not going to solve decarbonisation on its own, for example. We need collaborative effort to try to fix the ecosystem.’ However, that doesn’t mean that ESG shouldn’t be an area of competition for asset managers. Duncan said that firms should still see it as an area to differentiate themselves. ‘We should actually encourage that kind of competition,’ Duncan said. ‘But fixing some of the more systemic issues does require collaboration. That is both what I would call horizontally – which is peer to peer among asset managers – but also vertically across the ecosystem – with consultants and asset owners and regulators. Bigger shift ‘That is a feature of the modern evolution of governance,’ Duncan added. ‘We went through a period of strongman, go-it-alone, win-at-all-costs global politics very recently, but what is emergent is that solving some of these big systemic risk issues does require multilateralism. So, collaborating on ESG is reflective of a much bigger shift in the global governance arena.’ Practically, however, forming this collaboration isn’t always straightforward. ‘Unfortunately in corporate South Africa, sometimes the approach is to “divide and conquer”,’ Aeon’s Mohamed said. ‘They only want to meet us one-on-one. That can make collaboration difficult. But the same is true for asset managers. Many prefer an insular approach. When it comes to collaborative engagements, the big guys are very reluctant to collaborate with you.’ Raine Naude, an ESG analyst at Allan Gray, said that this is not without reason. ‘We do respond to other asset managers when they contact us about ESG concerns,’ she said. ‘But it is generally something we prefer to do individually when contacting companies. On one hand you have to be careful around the legal issues of acting in concert, and on the other hand you have to be careful about having constructive conversations.’ In Allan Gray’s case, a key part of its brand is being independently minded. This also features in the firm’s thinking on how to approach ESG. ‘When other asset managers have approached us, we always hear them out,’ Naude said. ‘There have been times we have supported them. We appreciate that we have influence. We are fortunate that when we ask companies to meet on these issues, we always manage to get a meeting. Smaller managers and NGOs may not get the same time. And when NGOs send me their concerns, I will raise them at these meetings. ‘But we find we can still engage constructively ourselves. And that is something we are trying hard to do. ESG has become very topical, so we want to make sure every step we take is considered and right for our clients, rather than just jumping on every initiative because it’s there.’
The role of investors in closing the ever-widening income inequality gap
Views on the causes of social inequality and the solutions for it have underpinned an array of socio-political/economic systems through the ages, each with their unique approaches to resource allocation and wealth distribution. A persistent feature of history is that extreme social inequality is dangerous for a society as it leads to social disruption, which, ultimately, has negative consequences for stable, long-term economic growth. One aspect of social inequality is income inequality, which can reach extreme levels and materially jeopardise societal and market stability. South Africa’s extreme wealth and income inequality should be a worry to all South Africans, particularly financial actors with an interest in the long-term stability of society. Within the public market context, resolving for equitable reward across shareholders, executives and labourers is an issue that has had different remedies, some with more success than others. Take for example the well-intentioned efforts in the US, which, in 2003, required public disclosure on executive pay, premised on the idea that sunlight is the best disinfectant. Yet this has done nothing to curb growing wage gaps and, in fact, there is now a body of research that suggests that simple public disclosure has, in part, precipitated an upward spiral of executive salaries in the US. In South Africa, the King CodeTM has long recognised the importance of remuneration in responsible corporate citizenship. However, it was only in the most recent version of the Code that the concept of fair and responsible executive remuneration, regarding overall employee remuneration, was introduced. The latest version of the Code also introduced the concept of mandatory engagement and commitment to changing remuneration practices if more than 25% of shareholders voted against the company’s remuneration policy, its implementation report or both. Notwithstanding the introduction of these recent positive steps, the key issue left unaddressed is that shareholders of SA listed companies still only have a non-binding vote on all aspects of executive remuneration. For the 2020 proxy voting season, some 16 JSE-listed companies had more than a 25% vote against their remuneration policy, and a further 26 JSE-listed companies had votes of more than 25% cast against their remuneration implementation reports. As investors express their views on renumeration more clearly, there will be growing demand for transparency on remuneration data. One important aspect of assessing ‘fair and responsible’ renumeration in the context of SA’s inequality challenge is the quantum of pay. Prime broker, Peresec, has found that CEOs of the JSE’s top 100 companies earned 56X the single-year cash remuneration of their average employees in 2014, and this grew to 103X in 2017 before subsequently moderating to 48X in 2020, with the negative impact of the pandemic on CEO short-term incentives. Some CEOs during the period earned as much as 1500X their average employees in single-year cash remuneration. In other words, for much of the last seven years, CEOs earned more in any single year than the average employees in their companies would have earned in their entire lifetimes, even before considering long-term incentives. As striking as these numbers are, calculating them required resorting to a relatively crude process of extracting disclosures around staff costs and headcount from company reporting. This type of imprecision in data for both the numerators and the denominator inhibits the ability of investors to make a clear assessment of ‘fairness’ of pay. Addressing this could potentially be achieved by mandating specific disclosures of inequality data. Most critically, disclosure of single-figure total remuneration data of executives (and anonymised disclosure for the highest paid employee should they not be a group executive) could be mandatory for all public companies. Secondly, disclosure could also be made of the total remuneration of the lowest paid permanent employee as well as the lowest paid temporary employee. Thirdly, disclosure of the remuneration multiple between the top and bottom decile of earners could provide visibility of internal wage gaps. All this data exists within companies and is certainly relevant to both society and investors. The inevitable introduction of ‘say on pay’ legislation should come as no surprise to executives of JSE-listed companies, especially given the very real income inequalities that exist in SA. The provision of regulation to facilitate greater shareholders’ ‘say on pay’ would be an important step in closing the accountability loop between beneficiaries, asset owners, investors and the market, and it enables us to further deliver on our commitment to responsible investment practices. However, the exact nature of any ‘say on pay’ legislation should be coupled with an equally vigorous debate on regulation and policy related to job creation.
Jon Duncan Head of Responsible Investment, Old Mutual Investment Group
Robert Lewenson Head of Stewardship, Old Mutual Investment Group
Waseem Thokan Head of Research, Peresec Prime Brokers
ESG investing is here to stay
In an environment where investors were increasingly considering the impact of their investments on the sustainability of the planet, Covid-19 further confirmed the shortcomings of economies and societal systems. In the first quarter of 2021, responsible investment funds attracted 17% more assets and touched almost USD2 trillion, achieving a fourth consecutive quarter of worldwide record inflows. The 2021 Financial Adviser Survey found that 73% of financial advisers report that their clients are more interested in Environmental Social and Governance (ESG) investing, resulting in two thirds investing their clients’ money in ESG solutions. What is driving these record inflows? Let’s look at some of the factors driving the exponential growth in ESG solutions: 1. Performance According to Morningstar, demand for ESG funds has, in part, been driven by performance. Refinitiv Lipper data showed that ESG funds increased by 4.6% this year on average, compared with a 1.1% gain for non-ESG funds and that ESG funds have outperformed their non-ESG peers in 7 out of the last 10 years. 2. Lower downside risk A report from Morgan Stanley analysing the returns and downside deviation of 10 723 fund, had two key findings: - There is no financial trade-off in the returns of sustainable funds and traditional funds. - Sustainable funds demonstrated a 20% smaller downside deviation, meaning lower market risk. 3. Sustainability objectives The growing global threat of climate change, resource depletion, rising pollution and unethical practices in the private and public sector led to an escalation in demand for more ethical practices and products from companies and governments alike. It seems that for investors it's no longer about profit at any cost. This is a strengthening trend internationally. The expectation is that it will also grow in South Africa where the retail ESG funds market is still young, with very few funds on offer. Barriers to advisers recommending ESG With the exponential growth in ESG investing, understandably some areas are not yet fully developed or have fallen behind the speed of growth. In the 2021 Financial Adviser Survey, financial advisers identified the following top three barriers to promoting ESG investments to their clients: • 65% of advisers cited lack of a clear set of standards and definitions. • 52% of advisers cited lack of readily available data solutions. • 52% of advisers cited greenwashing, where companies make unsubstantiated or a misleading claim about the environmental benefits of a product, service, technology, or company practice. Old Mutual is a leader in ESG solutions Old Mutual Unit Trusts was one of the first investment companies to offer ESG funds to the retail market in 2018 with the launch of two global funds namely, the Old Mutual MSCI Emerging Markets ESG Index Feeder Fund and the Old Mutual MSCI World ESG Index Feeder Fund. In June 2020, we launched the Old Mutual ESG Equity Fund, invested in the local equity market for investors who primarily seek exposure to a South African General Equity Fund with a high ESG focus. For more than a decade, Old Mutual Investment Group has played a proactive role in creating long-term sustainable outcomes for clients. These solutions are a product of ESG research and integration into our investment processes. They are an integral part of investing for a future that matters, as they give unit trust investors an accessible and affordable opportunity to use their direct investments as a force for good by investing responsibly. Increasing transparency with ESG ratings Old Mutual Unit Trusts rated and published ESG scores for all our unit trusts listed on the Old Mutual Wealth platform through a collaboration with MSCI, a global leader in investment research, in response to the growing demand for more transparency and a greater variety of sustainable investments. The funds on the platform are rated by measuring the ESG score of the underlying securities and assets they invest in. They are given a score that reflects how well they perform on a set of ESG measures. The future Generation Y & Z are future owners of the largest generational wealth transfer estimated at about USD30trillion, from baby boomers to millennials over the next decade. They are also known to prioritise responsible living and have a huge sense of responsibility. As younger investors pave the way, it’s clear that ESG investing is not a passing fad. It has the power to influence real social and environmental change across the globe for all investors. Find out more about range of Responsible Investment unit trusts solutions at www.oldmutualinvest.com/responsibleinvesting.
Elize Botha Managing Director, Old Mutual Unit Trusts
