Environmental, social and governance petitions, protest, even prescription, are not bending state policy or shifting human behaviour. The tipping point towards climate control, social upliftment and ethical business practice is investor sentiment, and the billions in assets under management that come with it. The evidence shows that even if investors don’t flag environmental cataclysm as a major concern, those who do are reaping the rewards, and the planet will be all the better for it.
Although sustainable investing is still in its infancy, there is still a lot of debate about the best approach and international standards are yet to be established to govern it.
But the conversation is heating up, and it is all about the UN Sustainable Development Goals, carbon footprint, ethics, or some other desired social outcome. And fund managers and investors are paying attention. Today, investment in global environmental, social and governance (ESG) values is estimated at more than $20-trillion in assets under management.
But issues ranging from climate change to executive remuneration and the gender pay gap have accelerated the integration of ESG into investment portfolios. The Financial Times reports that more than a third of an audience of asset managers and pension funds attending MSCI’s annual investing conference in London earlier this month expected to see the share of global assets operating on ESG principles more than double from about 25% today to between 50% and 65% in the next five years.
Ten years ago, the use of ESG metrics was a niche activity and not well understood, or applied, for that matter.
“There has long prevailed an alleged trade-off between investment returns and allocation of capital,” says Zack Bezuidenhoudt, head of South Africa and Sub-Saharan Africa Dow Jones/S&P Indices.
“Today ESG investing is more mainstream and accessible, and benchmarks now reflect strategies which are no different from the mainstream index on which it is based.”
It is for this reason that new stock indexes are popping up all over the place. Traditional companies such as S&P Dow Jones and MSCI, as well as specialist organisations such as Refinitiv and Equileap, are producing lists of equities that meet their criteria for socially responsible investing.
In April, S&P Dow Jones Indices launched the S&P 500 ESG Index, which excludes companies that don’t meet certain ESG criteria, from the baseline 500 companies. The goal of the ESG index is to closely replicate the risks and returns of the S&P 500. The S&P 500 ESG Index aligns investment objectives with ESG values.
In the coming months, S&P DJI will also launch a global family of ESG indices based on its other widely tracked regional and country-specific large and mid-cap benchmarks used in the Americas, Europe, the Middle East and Africa (EMEA), and the Asia-Pacific (APAC) region.
“That is appropriate for someone who is willing to take on those risks and is of super-high conviction that they can use those indices to achieve a certain return. The S&P 500 ESG index isn’t trying to offer that. It’s about getting market return, but with the ‘social alpha’ of just investing in companies at the top end of sustainability and governance metrics,” says Bezuidenhout.
SPDJ manages four such indices in South Africa, with the latest being introduced in May last year. S&P South Africa Domestic Shareholder Weighted Capped ESG Integrates sustainability criteria while targeting the risk-return profile of the S&P SA DSW Capped Index. It excludes companies involved in tobacco, controversial weapons and those non-compliant with the UN Global Compact.
It is important to understand where the concept came from. It has been floating around since 2005, evolving from the Socially Responsible Investment (SRI) movement, which has been around much longer. While the latter focuses on ethical and moral behaviour, avoiding industries like alcohol, tobacco or firearms, ESG is based on the assumption factors that have financial relevance.
In 2004, the JSE became the first emerging market exchange to create an SRI index to provide investors with a means of identifying listed companies with sound ESG policies and practices.
The index, however, received much criticism over the years around lack of transparency, the selection criteria and underperformance relative to the parent index, writes Kim Johnson, portfolio manager for customised solutions at Old Mutual, on the company website.
“The flawed selection criteria was demonstrated by the inclusion of stocks like Lonmin and African Bank in the index. And, as the repercussions of the Marikana tragedy played themselves out and several issues emerged regarding Lonmin’s financial stability, it continued to be part of the SRI Index. Similarly, African Bank remained in the index until its suspension in August 2014. This has left very little confidence from investors on the quality of the index’s screening.”
Old Mutual launched the first responsible investment equity index fund in South Africa, the Old Mutual Responsible Investment Equity Index Fund, in 2016. The fund invests in companies that have high sustainability measures, by using MSCI research methodology and a best-in-class approach to target sector weights.
Elize Botha, managing director of Old Mutual Unit Trusts, says: “Investors are not only looking for more affordable ways to invest, through the index or passive investing, but are now questioning how sustainable their investments are.”
ESG may not be ready to take over traditional investing in SA just yet, but Regulation 28 of the Pension Funds Act does include a requirement for funds to consider responsible investment practices. Furthermore, a proposal by the FSCA, if legislated, will require the country’s pension funds to show how they apply ESG factors to assets they intend to buy; how regularly they measure the compliance of their assets to their sustainability criteria; and to report on how these provisions are being met in both financial statements and annual trustee reports.
South African funds managers are already, by and large, signatories to the UN-supported Principles for Responsible Investment (PRI) initiative, an international network of investors that seeks to understand the implications of sustainability for investors and supports signatories to incorporate these issues into their investment decision-making and ownership practices.
Meanwhile, more indices and benchmarks will appear, and associated rules and regulations and, as ESG values become increasingly important, companies that adhere to them should get larger and push out companies that do not.
Being responsible has never hurt anyone.
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