IN A NUTSHELL
- The integration of environmental, social and governance (ESG) factors into an investment process ensures sustainability
over the long term.
- This is no longer a theoretical concept and can be applied to investment analysis.
- Embedding an ESG framework into the investment process gives investors the best chance of meeting their future
A liability-driven investment (LDI) approach is when an
investor’s liabilities drive their investment strategy, an
approach we believe that all investors should adopt.
How this approach is applied depends on the specific
investor’s financial position and behavioural factors.
For example, a risk-seeking individual with wealth way in excess
of their living requirements will have a very different LDI strategy
to a retirement fund that is straining to meet its inflation-adjusted
obligations to its pensioners.
It is important to note that in some cases, such as defined benefit
funds, liabilities can be very long term in nature, and it is not
uncommon to see liability obligations that extend in excess of
100 years. These investors need to take a very long-term view
when developing an LDI investment strategy.
If an investment manager truly takes a long-term view, it implies
that they have applied an environmental, social and governance
(ESG) lens to their investment analysis, because these factors have
a material impact on the sustainability
of the investment and therefore on
the investor’s liabilities. If, for example,
our generation chooses to ignore ESG
considerations, then future growth
rates can be expected to be lower.
The same would apply to future
discount rates (i.e. the rates that we
use to determine the value of future liabilities in today’s monetary
terms). This would result in liability values increasing in the future.
If future growth rates are lower, this, in turn, would decrease the
likelihood of being able to find suitable investments that will grow
over time to meet the projected liabilities. Incorporating ESG
considerations into the investment process is therefore critical.
Applying the theory
While ESG reporting and analysis is in its relative infancy and
much work is required to encourage greater transparency and
consistency of reporting, a significant amount of progress has been
made. It is also no longer a theoretical
concept and can, and should, be applied
to investment analysis.
Here is an example of how an ESG
framework has been applied to the South
African (SA) telecommunications sector.
The table reflects a sample of ESG risk
factors and their influence on creditworthiness and the subsequent
impact on the pricing of bonds that may be held in an LDI portfolio,
together with our respective views. Embedding an ESG framework
into the investment process becomes a “must” in terms of ensuring
a sustainable investment strategy. This will serve to give investors
the best chance of meeting their future liabilities.
Telecommunications ESG analysis using MSCI risk and opportunity factors