AT THE COALFACE
We spoke to some of our boutique heads to learn how they integrate environmental, social and governance (ESG) factors and realise responsible investment within their businesses.
Old Mutual Investment Group aims to invest responsibly with a long-term perspective to deliver superior returns and fuel employment, skills development and economic growth. Our investment capabilities are managed by independent investment boutiques, each with its own philosophy, proprietary research capability and robust investment process. We spoke to some of our boutique heads to learn how they integrate environmental, social and governance (ESG) factors and realise responsible investment within their businesses.
Q: FROM YOUR EXPERIENCE WITHIN THE ALTERNATIVE INVESTMENT CONTEXT, WHAT IS THE RELATIONSHIP BETWEEN SUSTAINABILITY OBJECTIVES AND ACCEPTABLE COMMERCIAL RETURNS?
PAUL BOYNTON, CEO: OLD MUTUAL ALTERNATIVE INVESTMENTS RESPONDS:
A: Investors looking to access opportunities which contribute to sustainable economic development need to look beyond traditional equity markets. The alternative investments we offer, into roads, housing, renewable energy, for instance, provide this exposure and our sustainability objectives allow Old Mutual Alternative Investments to focus on positive impact as well as positive returns. Nowhere is this more apparent than the Renewable Energy Independent Power Producer Procurement (REIPPP) Programme, where we are the lead investor involved in 20 renewable energy projects contributing to South Africa’s renewable energy targets, as well as with the Fourleaf Estate, Africa’s greenest affordable housing development.
Along with enhanced commercial returns, having clearly thought out and defined sustainability objectives bolster a company’s value through intangible assets, such as reputation, innovation and goodwill. Such assets are becoming increasingly important to a company’s worth, and therefore the positive relationship between sustainability objectives and commercial returns will only become clearer, fuelling other companies to increase their sustainability targets.
Q: WHAT ARE THE MOST SIGNIFICANT LONG-TERM ESG TRENDS THAT YOUR TEAM FEEL WILL IMPACT THE DOMESTIC MARKETS?
PETER BROOKE, HEAD OF MACROSOLUTIONS, RESPONDS:
A: We fundamentally believe that ESG is important in allocating our clients’ capital wisely. The reason for this is that we think a one-dimensional, valuation-only based approach is not optimal. Investors need to bring in a second dimension that includes what is happening in the overall environment and the themes that will ultimately drive valuations. That’s why our investment philosophy is premised on both theme and price. When thinking about “theme”, there are two critical components: duration (time) and extent. “Extent” considers whether an event will have a material impact on the underlying asset. We sometimes fear that ESG analysis falls into a box-ticking exercise exemplified by winning an award for reporting rather than focussing on the genuine themes that determine returns. Importantly, we believe these themes drive asset classes as well as securities.
The biggest drivers of domestic markets is what happens in the rest of the world. A number of big macro themes are coinciding to drive up political risk. For instance, the growth of China, the rise of automation and increased competition are all putting pressure on the “missing middle” of the electorates. This is, in turn, leading to a rise in populism and unexpected election results. We think this will result in greater volatility and lower returns.
On the local front, the growing number of unemployed youth, the prevalence of wealth inequality and the lack of government delivery are a dangerous mix. This will ensure extreme pressure on the fiscus, which will push us towards ratings downgrades and the economy stagnating. On a longer-term view, this means we favour an underweight duration in bonds in our portfolios, despite our short-term expectations of lower interest rates.
These same macroeconomic forces, and our historic legacy, will also ensure that transformation remains a priority. As a boutique, it is critical that we develop the next generation of black fund managers to maintain our legacy of delivering to client return expectations.
Q: IN YOUR BUSINESS, DO INVESTORS SEE A COMPELLING CASE FOR CONSIDERING NON-FINANCIAL FACTORS IN INVESTMENT DECISIONS? AND HOW IMPORTANT ARE THESE ISSUES FOR UNDERSTANDING THE SUSTAINABILITY OF LONG-TERM CASH FLOW FORECASTS?
TREVOR ABROMOWITZ, HEAD OF LIABILITY DRIVEN INVESTMENTS, RESPONDS:
In a Liability Driven Investment (LDI) framework, it is imperative to take non-financial factors into account when investing for the long term. There is growing evidence that suggests that ESG factors, when integrated into investment analysis and portfolio construction, may offer investors potential long-term performance advantages as these factors could have an impact on long-term cash flow forecasts. Non-financial considerations can be key indicators of other factors that could impact the quality of the investment over the long term and include, among others, the following:
- The impact the company is having on the environment, for example whether the company pollutes or emits hazardous emissions.
- How well the company looks after its staff in terms of labour and working conditions, health and safety and its staff turnover.
- The company’s compliance with the King III Code on Corporate Governance, the composition of the company’s board and its audit committee and the company’s focus on good corporate governance.
Generally, investments will not be selected or rejected solely on the basis of non-financial factors, but rather these will be taken into account as part of the overall investment thesis. It is therefore critical to have a framework that assesses – for every investment – the ESG factors impacting, or likely to impact, that investment. And having a team of experts, with the necessary experience and depth of resources, to assess the ESG framework is a must.
q: HOW DO ESG FACTORS IMPACT YOUR INVESTMENT ACTIONS?
PETER LINLEY, HEAD OF OLD MUTUAL EQUITIES, RESPONDS:
A: As a long-term investor, it is our view that incorporating ESG factors into our investment and responsible ownership decisions leads to improved risk-adjusted returns for our clients. In Robert Lewenson’s article he talks to global research done on successful management engagements enhancing alpha. At Old
Mutual Equities, we actively seek to identify issues that may materially impact the long-term value of a company and actively engage with management teams on these – with our shareholder voting rights being our point of influence. By way of example, these are a few of the issues we addressed in 2016:
Environmental: We joined the “Aiming for A” coalition of Anglo American shareholders in calling for a resolution to be tabled requesting the company provide details on their initiatives to combat climate change. The resolution was passed and Anglo is preparing to integrate climate-related financial disclosures into their mainstream reporting1.
Social: Health and safety scored as a critical risk affecting Gold Fields’ long-term strategy. We requested the company provide detailed information on initiatives to improve their occupational health and safety performance track record. These, and other material ESG risks, are now disclosed in their integrated annual reports.
Governance: We challenged a number of companies on their board structures and remuneration policies, with an additional focus on introducing ESG criteria into performance measurements. These companies included British America Tobacco, Standard Bank and Nedbank. All provided shareholders with satisfactory revisions to their policies.
Many ESG factors do not have an immediate impact on share prices. However, with our focus on investing in companies that clearly demonstrate an ability to create shareholder value over time, these factors cannot be ignored. To us it is evident that our analysis around sustainability and ESG factors contributes to the longer-term outperformance of our clients’ investments.