In many markets, investors are directing large amounts of money into funds that market themselves as ‘socially responsible’. According to Investment Company Institute trade group, these funds attracted $4.7 billion in the USA last year.
These inflows are also not just coming from a niche of investors with certain ideologies. It is becoming quite mainstream to recognise the material risks that environmental, social and governance (ESG) issues represent to companies and their shareholders.
“We’re getting away from the political arguments like is there climate change or not,” says the CEO of S&P Dow Jones Indices (SPDJI) Alex Matturri. “Whether you think there is or not, you know that there are impacts or potential risks. For example, what happens to companies in Cape Town that use a lot of water if you do go to Day Zero?”
In other words, responsible investing has become about far more than just screening out companies that may be doing something that is ‘bad’ for the environment, or have poor labour practices. It is about being aware of how these kinds of issues might impact on a company or industry and what that will mean for shareholder returns.
“We know that water is a risk, for instance, but how many people know that Saudia Arabia has the cheapest water in the world?” says Matturri. “It’s cheap because it’s subsidised. But what happens to a company that manufactures in Saudi Arabia if water there comes to a fair market price? That’s a risk that not many people have thought about.”
Thinking long term
Since screening for ESG issues is data-reliant, index providers like SPDJI and MSCI have naturally come to the forefront of the industry. It makes sense for them to build indices that select and weight companies based on various factors that identify more sustainable approaches and business models.
Significantly, these ‘socially responsible’ indices are in many cases showing out-performance relative to the market. Some argue that this is a cyclical phenomenon, mainly due to recent commodity price weakness and the related under-performance of commodity producers. However, proponents believe that there are sound business reasons why this is the case.
“The theory is that if you run your company for the long term, you will for example invest in educating your workforce, you will pay fair wages, and have a diverse workforce that brings in new ideas,” says Matturri. “Those are all factors that should help a company grow over the long term better than companies that are entrenched in their thinking.”
Matturri says that in some parts of the world, this is seen as a given. In Europe especially, “you can’t have a conversation with an institutional or retail investor without EGS being part of the discussion”.
Where does South Africa stand?
In South Africa, however, responsible investing is still viewed with a fair amount of scepticism by investors. This is despite a number of recent examples, such as African Bank and Steinhoff, of how material corporate governance issues can be, and the fact that South Africa is only one of two countries in the world that has its own responsible investment code.
The Code for Responsible Investing in South Africa (CRISA) was launched in 2011, and encourages institutional investors to integrate ESG issues into their investment decisions.
“South Africa and the UK are the only two countries that have their own codes like this,” says Duncan Theron, the CEO of investment advisory firm GraySwan. “So asset managers know that they have to apply their minds. It’s just a matter of who does it seriously and dedicates staff to it.”
While governance is an issue that most local asset managers recognise as very important, far fewer incorporate environmental and social considerations into their investment process. Tellingly, only a handful actually market the fact that they consider ESG issues at all.
This is indicative of how few investors see this as an important differentiator. So is the lack of funds that have a specific ‘socially responsible’ mandate.
“There are very few local products that fall into this category,” says Theron. “Pension funds may be able to find something local through direct private equity-type investments, but many don’t have a tolerance for private equity because of the liquidity issues.”
Changing the approach
Theron has therefore primarily had to advise clients into international equity funds with responsible mandates. Many of these have done extremely well.
“We have invested clients into products that have out-performed market by 3% to 4% at lower fees,” he says. “It remunerates you to be responsible.”
These experiences make him believe that there is significant scope for South African managers to come up with similar offerings in the local market.
“If you look at offshore research, and the support for these products in places in US and Europe, even private client investors are realising that it pays to be responsible,” Theron says. “People are seeing things are happening. We have water scarcity in South Africa, we’ve seen social issues like at Marikana. These issues are real, and we need to take them seriously.”