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While asset managers have traditionally focused on the financial dimension of risk and return in investments, many consumers have long had a wider view. Consumers have long been using their buying power to protest the status quo or to affect change by not shopping in stores where staff are mistreated or boycotting “rogue” states, such as South Africa, during apartheid.
Investment houses are increasingly broadening their understanding of risk and return, and investors are voting with their investment feet by moving to managers that attempt to bring about change by prioritising environmental, social and governance (ESG) principles.
Managers focus on ESG to avoid risks
For many, ESG factors are a critical aspect of risk management, as avoiding harm boils down to protecting profit.
Loshni Naidoo, chief sustainability officer at the JSE, explains that ESG investing involves a process where environmental (climate change mitigation), social (labour standards and human rights), and governance (internal and external risk management) factors are explicitly and systematically incorporated into decisions about how to allocate capital.
“The intention is to contribute to a specific environmental or social outcome in addition to generating a financial return,” she says.
More people are asking how the risk of destroying the earth and, potentially, humankind can be stripped out of the pursuit of profit and Linda Eedes, an investment professional at Foord, says understanding the risks posed by environment and social costs in the real economy is now central to investing.
It stands to reason that properly factoring these costs into what a company charges for its products and services would likely impact their bottom line.
“ESG factors are increasingly being identified as critical to evaluate in the context of identifying material risk and growth opportunities. These are all things that are critical either to the sustainability of a business, or the sustainability of business activities within the context of the greater world, or both,” Eedes says.
“Even if you don’t care about the sustainability of our planet or our species, even just from a financial perspective, we need to care about how companies are tackling these issues,” Eedes adds.
An ESG focus can capture returns
Besides containing risk, the focus on ESG in investing can generate environmental and social returns that are not taken into account in traditional assessments of performance. These returns may come from improved working conditions and pay for workers, reduced pollution and disasters that were averted.
These returns can, in turn, improve the financial dimension by, for example, improving productivity in companies that are managed by diverse and representative leadership teams where staff are treated well, reducing the cost of energy and avoiding lawsuits and environmental clean-ups.
Gontse Tsatsi, head of retail clients at Old Mutual Investment Group (OMIG), says Old Mutual has a focus on responsible investing because it allows the group to earn returns for investors at the same time as having a positive impact on the communities and environment in which investors operate.
He says the approach “is founded on the understanding that sustainability issues can and do influence long-term investment outcomes”.
“Issues such as resource depletion, climate change, poor governance and social inequality, pose both investment and systemic risks to our customers’ goals,” he says.
It’s about getting the returns but making sure that there is a world in the future in which the wealth investors accumulate and the goals they achieve can be enjoyed, he says.
It is not just about avoiding certain companies
Another area where traditional black and white responses have given way to more grey areas is the “invest or avoid” dilemma. Rather than simply avoiding companies that are not seen as responsible corporate citizens, fund managers tend to seek out opportunities to influence sustainability laggards.
This is known as active ownership.
Eedes says that at Foord they don’t believe that excluding companies that perform poorly on ESG measures necessarily helps to solve society’s problems. “We prefer to be part of the process that is moving companies collectively towards creating a cleaner world … solving society’s problems, rather than just avoiding them.”
Don’t worry too much about greenwashing
Change is creating noise and confusion. ESG cynics frequently mention “greenwashing”, where funds and companies claiming to have ESG credentials are found to be lacking in their commitment to sustainability.
“Regulatory pressure, particularly in regions such as Europe, has been a major driver of ESG, and as a result, financial incentives have been created for companies to jump on the ESG bandwagon,” says Eedes. “Many players in the investment industry have responded to these incentives, and not always for the right reasons,” she says, adding that “whenever there’s money to be made, there’s inevitably going to be activity that looks to tick the box”.
As the regulatory environment, locally and internationally, continues to evolve there are hopes that greenwashing will soon be remembered as merely a teething problem of the evolution of investment practices.
ESG investors are creating an investment trend
Naidoo says a strong sustainability focus translates to resilience, innovation, and in the long-term creates value for investors – the perception is that a company is better equipped to handle unforeseen challenges and capitalise on emerging opportunities.
She says beyond perception, there are now measures and benchmarks, that demonstrate how sustainability can affect operating profits and increase productivity.
Tsatsi says Old Mutual believes that the focus on sustainability is a long-term investment theme that will be good for investors as it is reshaping competition across every industry.
“Companies that respond to this and innovate early will reap the benefits of stronger growth prospects, enhanced operating efficiencies, stronger social licence to operate, enhanced staff retention, lower cost of capital and, ultimately, stronger and longer competitive advantage,” he explains.
This chimes with the growing consensus that companies that embrace sustainability metrics will outperform in the long run. Besides, as Eedes adds “we believe that market forces [supply and demand] will eventually catch up with unsustainable business practices”.
She explains that there are many ways that these issues can directly impact a company’s bottom line beyond being fined or taxed, including assets, such as mines, becoming “stranded or obsolete” due to regulatory or environmental constraints putting pressure on, and eventually destroying, demand for the mined products.
Besides, there is a lot more than profit at stake, as Tsatsi adds: “Responsible Investing is rooted in an understanding that how we invest today determines the quality of our future. Simply put, if we continue to invest in unsustainable companies that erode public trust, pollute the environment, and perpetuate inequality, we should accept that this is the kind of future we will bestow on our future generations.”
This article was first publish on SmartAboutMoney.co.za, an initiative by the Association for Savings and Investment South Africa (ASISA).
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