Can we continue to sit back and say that responsible investing is a foreign notion? Investors are increasingly interested in the influence of environmental, social and governance (ESG) factors on their portfolios, driven partly by a desire for sustainable outperformance and to do the right thing.
A lack of potable water, acid mine drainage, income inequality, corruption and executive remuneration are just a few of the ESG issues companies and governments face globally.
As these issues can significantly influence investments, incorporating ESG is becoming an industry-wide standard. Asset managers are grappling with how best to assess ESG and how they apply and measure the impact of these considerations on investments.
Social consciousness
A November 2015 Morningstar report - What Factors Drive Investment Flows - found that investors expressed a strong preference globally for funds that invest in a socially conscious manner.
The report found that equity funds that say they are socially responsible receive 0.40% greater flows a month than funds that do not.
According to the report; we do not have any strong story to tell for why this difference exists, though these differences do seem to be ingrained and persistent. Investors nearly universally preferred funds with socially conscious agendas.
A watershed year
2015 saw a significant increase in the integration of ESG principles globally into the investment decision-making process. According to a recent Wall Street Journal article, there was a 29% increase in signatories to the United Nations’ Principles for Responsible Investment (UNPRI) initiative last year. Large international financial institutions BlackRock and Goldman Sachs have also launched investment products to help align investors’ portfolios with their interest in responsible investing.
Because of their size, asset managers are in an influential position to positively influence ESG policy and practice in the corporates in which they are invested.
Settling fears
Investment managers and their clients have historically been concerned that responsible investing automatically means a sacrifice of returns. While there is no conclusive evidence that incorporating ESG results in better investment returns, we believe this approach helps us assess operational and financial risk, which leads to better evaluation and forecasts.
However, questions still remain over the lack of agreement on what exactly constitutes sustainable investing and the absence of a standardised audit system to assess company activities across sectors.
For example, companies in the paper and forestry industry such as Mondi and Sappi stand out because of the WWF and ISO14001 certification requirements for forestry conservation. This level of disclosure is not required of companies in other industries. As ESG disclosure is not mandated, it often depends on company budgets and capacity.
A unified approach
The UNPRI initiative and the Code for Responsible Investing in South Africa (CRISA) enforce the values of ESG.
The UNPRI is an international network of investors working to promote responsible investment. It has over 1 380 signatories, including asset owners and investment managers who are collectively responsible for assets in excess of $59 trillion; about half of all institutional assets globally.
Signatories must acknowledge the relevance of ESG factors to the long-term health and stability of the market and incorporate these into their investment decision-making and ownership practices. The initiative aims to contribute to the development of a more sustainable global financial system.
Locally, CRISA provides the investor community with guidance on how to give effect to the King Report on Corporate Governance in South Africa (King III) as well as the UNPRI initiative.
Potential challenges
Asset managers implementing ESG principles into their portfolios view active ownership and investing for the long term as fundamental to influencing corporate behavior. This can be done through proxy voting and continuous engagement with company management.
This kind of pressure can encourage companies to change and become better corporate citizens, and is more effective than selling out a position.
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