What are the benefits and challenges around sustainable investing for pension funds?

ESG and sustainable investing are all the buzzwords these days, but what are the benefits and challenges around sustainable investing for pension funds? Pensions & Investments Actuary, Managing Director of MDM Actuaries and Chairman of the Actuarial Society of South Africa’s Alternative Investments Forum, Malizole Mdlekeza, takes a look

It has become the latest buzz acronym for companies or entities intent on establishing that they have a clear purpose and positive impact on the plane: ESG.

But while it is becoming increasingly harder to find a listed South African company that does not flaunt its ESG (Environmental, Social and Governance) ratings when reporting results, many observers are divided on whether it is a true reflection of a company’s resilience and sustainability credentials, or whether it is just the latest corporate tick-box exercise.

This principle extends to institutions investing into those companies.

For some investors on the cynical end of the spectrum, ESG is merely the latest public PR exercise, and they believe investing for impact necessarily means sacrificing returns.

For others, sustainable investing (using ESG metrics or tools), when done properly rather than as a tick box exercise, or via ‘greenwashing’ for example, can have positive effects on investors and society as a whole.

Where does the truth lie, and how does the SA retirement fund industry currently feel about the matter? Can conscious, ESG-driven sustainable investing meet their required return objectives?

Currently, all indications are that it is only the larger retirement funds that are more likely to actively engage with their investee companies or entities on ESG related matters.

Most of the smaller retirement funds engage less, or do not engage at all.

According to a report which was jointly released by the FSCA and the IFC last December, most retirement funds have not yet signed up to or aligned with any recognized national or international initiatives related to sustainable investing. Of those that have, however, the majority have aligned with the Code for Responsible Investing in South Africa (CRISA), as well as the United Nations Principles for Responsible Investing (UNPRI).

Of the retirement funds that indicated having some elements in place to implement an ESG integration strategy, 32% say they engage in a periodic review of ESG risks at portfolio level, followed closely by those that have a formal inclusion of ESG integration in asset manager mandates.

The report also indicates that relatively few retirement funds (10%) have dedicated staff to manage or monitor ESG risks.

So despite all the talk around ESG investing, very few funds are currently walking the walk when it comes to it.

It is not surprising, given that there are challenges to the implementation of ESG-based sustainable investing.

The FSCA and IFC report indicated that while funds are willing to increase their allocations to investments that have a positive social impact, some of the challenges in adopting a formal sustainable investment strategy include:

•  A shortage of relevant investment products and pipeline, as well as a lack of definitional clarity for these types of investments;
•  A lack of depth of knowledge on responsible or impact investing across the value chain - from trustees, to consultants and underlying fund managers; and
•  The difficulty in monitoring and reporting on the impact of investments.

Other impediments to implementing an ESG strategy at an overall fund level include: building capacity amongst trustees and principal officers; putting in place a system to assess, monitor and report on ESG risks; and compiling a list of core questions to ask fund managers on a regular basis.

The other current challenge is information - or rather lack of it.

The report and survey findings show that most retirement funds do not currently collect data on ESG risks in their assets. Those that do track these metrics use a (perhaps confusingly) diverse set of tools, including asset managers’ feedback, company reports, ESG tracking systems, and external advisory companies.

Many retirement funds have indicated they would need consistent data collection and classifications across their investments from asset managers in order to monitor and report on ESG risks.

Given the challenges in implementation and the potential or perceived risks to returns, should funds bother?

While responsible investing will not necessarily solve all of South Africa’s challenges, given the size of the retirement fund industry - sitting at roughly two thirds of the country’s savings pool of R6.6-trillion, according to ASISA’s January 2021 figures - the effect that properly implemented sustainable investing can have on the economy and broader society simply cannot be ignored.

If we look at indices such as the MSCI South Africa ESG,Leaders Index over the past 10 years for example, which provides more exposure to large and mid-cap stocks of companies with higher ESG scores relative to their sector peers, there is empirical evidence to show that ESG stocks or assets can and do outperform their non-ESG counterparts.

The positive net outcome, if implemented correctly, is enormous … and, given the challenges confronting South Africa, the retirement fund industry should make a concerted effort to move ESG from just another tick-box exercise, to a real way to make a difference.