Your guide to investing where your heart urges you to

A stock quotation board at the Johannesburg stock exchange. (Kevin Sutherland, Gallo)

A stock quotation board at the Johannesburg stock exchange. (Kevin Sutherland, Gallo)

From the tragedy that was Marikana to the scandal Ford is facing over spontaneously combusting Kuga vehicles, the effect companies have on people and the places they operate in can affect their bottom line and their ability to raise money.

In South Africa, there is a growing number of financial products that focus on responsible investment, aimed at getting companies to account — literally — for how they deal with environmental, social and governance (ESG) issues.

If you are an ordinary investor like me who may be interested in using what money you have as a nest egg and at the same time doing some good in the world, this can be a little bewildering.

There is still some confusion between responsible investing and other concepts such as impact investing or green investing. And, although there are a growing number of products and tools that focus on ESG factors available to institutional investors, there are fewer options available to retail investors, particularly when it comes to inexpensive, passive investment tools such as exchange traded funds.

But this is changing as people become more socially and environmentally conscious.

Research from developed countries shows that millennials, those born between 1982 and 2004, are more aware of these issues and more interested in making investments informed by them.

Research last year by the Canadian Responsible Investment Association revealed that millennials are 65% more likely than baby boomers, the generation born after World War II, to consider ESG questions when making investments.

We are not talking chump change here, with another report estimating that roughly $30-trillion in financial and nonfinancial assets will be passed from baby boomers to millennials in the United States alone.

Responsible investing is not the same as impact investing or socially responsible investment (SRI) and does not, for instance, require that investors screen out some companies or sectors.

According to the United Nations’ Principles of Responsible Investment (PRI) initiative, it simply requires including ESG information in decision-making.

According to the PRI, although some approaches to ethical investing aim to combine financial returns with ethical returns, responsible investment can be pursued by investors whose sole purpose is financial return.

It argues this is because “to ignore ESG factors is to ignore risks and opportunities that have a material effect on the returns delivered to clients and beneficiaries”.

In South Africa, responsible investing is included in an amendment to regulation 28 of the Pensions Fund Act in 2011.

It says in its preamble: “Prudent investing should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance character”.

Several South African firms are also signatories to the PRI, which has a local embodiment — the Code for Responsible Investing in South Africa (Crisa).

The JSE was the first developing country stock exchange to launch a socially responsible investment (SRI) index, which it did in 2004. But, over time, questions were raised about the selection criteria and its performance, and in 2015 it was replaced with the responsible investment index series, in partnership with index provider FTSE/Russell.

According to Corli le Roux, the JSE’s head of sustainability, the index assesses the disclosure of ESG issues, rather than being a measure of what makes a sustainable company.

“What we have always been trying to achieve is to positively influence corporate behaviour and increase their transparency, which then increases their accountability to the stakeholders that look at that information,” said Le Roux.

The rating model assesses a company’s exposure to each of the three ESG pillars as well as a range of themes under each pillar. It is then scored against these themes and pillars, culminating in one rating.

This choice of methodology is a reason a company such as British American Tobacco, a firm not everyone is likely to associate with ethical investment, makes it on to the index.

There are two indices in the series — the FTSE/JSE responsible investment (RI) index, which is a market cap weighted index and incorporates all eligible companies with an ESG rating of two or above; and the FTSE/JSE RI top 30 index, which is an equally weighted index and comprises the top 30 companies ranked using the FTSE ESG rating.

In other markets, particularly in Europe and the United States, there is still a strong bias towards excluding some companies from portfolios on ethical grounds, Le Roux said.

In South Africa, given the nature of the economy and the extent to which large companies are active in sectors that might otherwise be excluded, it is better to include them and enable engagement over ESG concerns.

Mike Davies, a director of Kigoda Consulting, which specialises in ESG research and analysis, said that although several South African market participants have signed on to initiatives such as the PRI and Crisa, there are areas that could be strengthened.

For one, individual pension fund holders are not as active or empowered as they could be when it comes to holding their pension funds accountable on social or ethical issues. As owners of capital through their pensions funds, individual members should be asking their trustees how ESG issues are factored into their investment mandates.

In addition, South African asset managers have typically opted to engage companies on issues “behind closed doors”.

“This makes it difficult to establish the extent to which there is engagement [on ESG factors],” Davies said.

Although there is a growing range of responsible investing platforms for institutional investors, for retail investors, the choices are less diverse.

This is because of a combination of factors, including financial advisers’ level of understanding about responsible investment. In addition, funds established early on in the evolution of socially responsible investing in South Africa did not perform well, contributing to a perception of lack of demand from investors.

The industry has also moved towards “integration”, Davies said. Rather than creating products explicitly labelled as responsible investment, some providers claim to incorporate ESG factors in the analysis methodologies of all their funds.

Again, he added, it can be difficult to ascertain the extent to which asset managers actually do incorporate ESG issues in practice.

Invest responsibly
As interest in responsible investment grows, new products to meet this demand are on the rise. For instance, the passive investment provider Coreshares offers its green exchange traded fund (ETF), which tracks the Nedbank green index.

Responsible investment funds are also increasingly holding their own in terms of performance.

The Old Mutual Investment Group developed its own South African environmental, social and governance (ESG) tracking fund, the Old Mutual responsible investment equity index fund, the first local tracking fund aimed at institutional investors.

It uses a rating methodology different from that of the JSE, preferring that of the index provider MSCI, given past problems with the performance of the JSE’s old socially responsible investment (SRI) index, according to Kim Johnson, its index portfolio manager.

The responsible investment equity index fund dispelled questions about performance, showing cumulative returns of 71.13% between October 2012 and December 2016, compared with returns on the JSE all share index/shareholder weighted index of 62.85%.

Old Mutual also has two global ESG tracking funds, which follow the MSCI world ESG index and the MSCI emerging markets ESG index.

Given a growing interest in a responsible investment platform for retail investors, Johnson said Old Mutual is considering the creation of a rand-denominated unit trust on the back of its Old Mutual MSCI world ESG index fund.

According to Angelique Kalam, the manager of sustainable investment practices at Futuregrowth Asset Management, the amendment to regulation 28 granted retirement funds the flexibility to increase their total aggregate exposure of unlisted assets, including equity and debt, which may not exceed 35% of the fund value.

This has helped drive flows to socially responsible investment (SRI) funds locally, she said.

But Kalam differentiates between responsible investing and a focus on ESG factors, and socially responsible investments, which focus on “how money is deployed in terms of a specific developmental mandate”.

In Futuregrowth’s case, it took into account South Africa’s infrastructure and developmental needs when it developed its SRI and identified those areas and opportunities that could make the most social impact through its investments, Kalam said.

The growth in two of the com­pany’s flagship funds is indicative of the extent of inflows into SRI funds, said Kalam.

The Futuregrowth infrastructure and development bond saw a cumulative growth in assets under management (AUM) over the 10-year period ending December 2016 of 205%, with the fund value reaching R12.1-billion, compared with 10 years ago when it was R3.9-billion.

Similarly, the Futuregrowth development equity fund also reached new highs, going up to R1.9-billion, with cumulative growth in AUM of 1050%, compared with 10 years ago when the fund value was at R168-million.

There is a misconception that returns are forfeited for the sake of social or developmental impact, said Kalam.

But the infrastructure and development bond fund, Futuregrowth’s flagship SRI debt fund, has a 21-year track record and has achieved a return of 9.6%, compared to the all bond composite index (ALBI) benchmark of 7.65% for the one-year period, and 9.4% compared with the ALBI of 6.83% for the three-year period ending September 30 2016.

NOTE, January 30: Mike Davies, director of Kigoda Consulting, was erroneously referred to as Mark Davies. The Mail & Guardian apologises profusely for the error.

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