In seeking to respond to increasing pressure for ‘responsible investment’, various financial services players are looking for a yardstick that can inform sound investment decisions as well as influence corporate behaviour. Here we unpack some of the issues.
There is a subtle difference between responsible investment and investing for societal impact. In the latter, emphasis is placed on investing in themes aimed at redressing social and environmental challenges, and the investor may not be focused only on financial returns. Such themes include education, healthcare, agriculture, public transport, infrastructure, water, low carbon energy, affordable housing, food and waste management.
If that is investing for societal impact, what is responsible investing? Is it the inclusion of social issues, such as fair trade and human rights, or does it require that we avoid certain industries such as alcohol, tobacco, gambling and weapons?
Responsible investing – guidelines from industry
According to the UNPRI, responsible investing is an approach to investment that “explicitly acknowledges the relevance to the investor of environmental, social and governance (ESG) factors, and the long-term health and stability of the market as a whole”. This is supported by local policy-making in the form of the Code for Responsible Investing in South Africa (CRISA), which was launched in 2011.
CRISA, according to John Oliphant, chairman of the stakeholder committee that drafted the Code, and Principal Executive Officer at the Government Employees Pension Fund (GEPF), is a set of guidelines intended to “empower the beneficiaries of investments made by institutional investors to ask the right questions and to select responsible custodians for their investments”. In particular, the Code reinforces the revised Regulation 28 of the Pension Funds Act, requiring pension fund trustees to give appropriate consideration to any factor that may materially affect the long-term performance of a fund’s assets, including ESG.
If you ask a pension fund beneficiary, responsible investing would strike a chord. The long-term saver wants to be sure of a steady, inflation-beating pension. For the investment return to be steady, the pension fund manager has to reduce long-term risk. And to beat inflation (normally by a target margin of 4.5%), cover taxes and investment fees, the fund manager is obliged to back companies that can compete effectively against often ruthless competition. In the short term at least, strong performing companies may not be proactively chasing business specifically aimed at impacting positively on society.
Jon Duncan, Head of Sustainability Research and Engagement at OMIGSA, points out that equities listed in South Africa generally have limited direct exposure to societal impact themes as compared to more specialised (and less liquid) asset classes such as fixed income and private equity. However, he notes that in a concentrated listed market dominated by a number of large institutional investors, a strong responsible investment (RI) mandate can potentially be an important driving force for systemic change in corporate behaviour. Naturally, such change would need to be supported by an investment case showing the rands and cents value proposition.
Non-financial issues, i.e. the soft issues that can create or destroy intangible value, are excellent tests of the quality of a company’s management team.
What corporate behaviour answers the RI mandate?
This was the question the JSE’s Socially Responsible Investment (SRI) Index, launched in May 2004, sought to answer. Companies were (and still are) assessed across a set of ESG criteria, looking at policy, management, performance indicators and reporting. Naturally, it did not take long for companies to create policies and reporting to tick the required boxes and gain inclusion to the index. The same challenges have been encountered by many other initiatives, including the Global Reporting Initiative, rendering the results only mildly indicative to the asset manager looking for long-term gains at reduced risk.
Duncan points out that the responsible asset manager is looking to understand the scale of ESG risk as well as assess the quality of management’s response to these issues. Duncan argues that such an assessment provides a proxy measure for the quality of management and its strategic positioning relative to its peers.
This is not so easily done. Glenn Silverman, Chief Investment Officer at Investment Solutions (IS), believes managers that consider sustainability issues when evaluating investment opportunities are better informed and more likely to be able to meet the needs of clients and society. IS believes one way to reveal the quality of an asset manager is to assess its ability to consider, evaluate and address the softer aspects incorporated within an ESG lens. Towards this end, the Investment Solutions Responsible Investing Survey, first launched in May 2012, seeks to gauge the status of responsible investing in the asset management industry and to track progress towards integrating ESG into managers’ investing process.
According to Lisa Kusters, Manager Research Analyst at Investment Solutions, the survey revealed a lack of clarity as well as some frustration among asset managers as to what the practical implications of implementing responsible investing are, and whether clients are ready to accept that a focus on sustainability requires a shift in focus from short to long term.
Concerns should be relevant to each industry
In the meantime, across the pond, the Sustainability Accounting Standards Board, a non-profit based in California, has stepped up to the plate to help investors understand ESG impacts across a variety of industries for companies traded on the U.S. exchanges.
SASB believes that every investor has the right to material information and is set on working out the relative importance of stakeholder concerns. Once the list of issues and their materiality is mapped across industries (indeed across world regions too, for emerging market issues will be different from issues in developed markets), we can start to assess the maturity of companies’ response. The SASB has only completed its assessment of one industry – the pharmaceutical industry – thus far, and estimates that it should complete the exercise before the end of 2015.
Winning companies will show a more mature response
Identifying issues, and their materiality across industry sectors, is one half of the job. The other half is to assess how ably companies are responding to the benefit of both society and their own competitive advantage. Take an issue such as product labelling. Most retailers will look at the latest legislation and put in place procedures for ensuring that their labelling complies with the law. But how mature is the response? What will the response do for customer goodwill? What will it do in terms of reducing business risks? How is it positioning the company to grab the moral high ground and maybe win over a new and more discerning market segment? These questions can only be answered if the leadership applies its mind, engages with its customers and suppliers, measures its performance, figures out a strategy and shares its plan with its investment community, most obviously through its reporting.
Duncan’s thesis is that listed companies can achieve greater direct societal impact in response to the pressure brought to bear by responsible investor activism. In effect, companies with an eye to future societal needs will enjoy better shareholder support for finding innovative solutions to underlying concerns, effectively creating new industries that address the societal themes listed at beginning of this article. The organic food industry might be an example of the effect of the extended influence of the product labelling issue. Early innovator farmers, food processors and retailers have created healthy lifestyle brands, capturing market share and improving profit margins.
This is the basis of the investment case for doing good business. If you are a responsible asset manager seeking to optimise long-term returns and reduce risk, consider investing in companies that show their management is capable of a mature response to the most material issues facing that industry. Closer analysis will not only discern well-managed businesses, but also identify those that are positioning themselves better to address future priorities and risks. Such strategic, long-term thinking will surely create a better return for both the investor and for society.
Source: Sustainability Review Issue 12: May 2013, Published on the Trialogue Website: May 11th, 2013
