Issue: Sep - Nov 2013
RESPONSIBLE INVESTMENT 1
Leading lights in SA
Cape Town is soon to host a major international conference on responsible investment. PRI executive director James Gifford highlights some crux issues grabbing the attention of institutional investors worldwide.
Last year’s tragic events at the Lonmin group’s Marikana platinum mine threw into stark relief the simmering safety and employee-relations problems at the London-listed firm. If investors still needed convincing of the potential materiality of environmental, social and governance (ESG) issues, Marikana should have convinced them.
Nearly 19% was wiped off Lonmin’s market capitalisation in the days following the disaster, and by end-2012 the stock had fallen by more than 60%. A year on, it has barely recovered.
While the tragedy at Marikana had its roots in complex social, political and industry factors, shareholders in extractive-industry companies will obviously want to see improvements in labour relations. They’ll also want to ensure that systems and processes are put in place to minimize the likelihood of similar incidents in the future.
What are companies doing to promote employee satisfaction and relationships with trade unions? How are they evaluating ways to manage these issues compared with industry best practice? How are they handling potentially difficult interactions with governments and security agencies?
Answers will be crucial in companies’ efforts to regain investor confidence. Of course, given the clear financial and human impacts of the Marikana events, these questions will be as much on the lips of conventional investors as those who consider themselves ‘responsible’.
But these latter investors – as well as a growing number of financial regulators and policymakers around the world – believe the practice of responsible investment (RI), and detailed analysis of ESG risk, can help prevent these issues from destroying shareholder value.
Some investors were acutely aware of the labour risks at Lonmin well before Marikana happened. For instance, ESG analysis by Alquity Investment Management in 2010 flagged poor employee relations. Despite Lonmin’s strong financial performance at the time, because of these concerns Alquity decided not to invest in the stock for its newly-launched Africa fund. So it avoided the subsequent losses.
Given the clear potential for ESG issues to be material, RI is considered a fiduciary duty of long-term investors. Moreover, in jurisdictions such as SA, it is also a regulatory duty.
Gifford . . . $34 trillion signed up
The Principles for Responsible Investment (PRI) organization was set up in 2006 by two United Nations bodies, UNEP FI and the UN Global Compact, with backing of 50 institutional investors. We define RI as an approach to investment that explicitly acknowledges the relevance of ESG factors to investors and the long-term health and stability of the market as a whole.
How investors choose to implement this approach varies widely. Traditionally, socially-responsible investors exclude from their portfolios companies that engage in activities with which they disagree, such as tobacco or weapons manufacture (so-called ‘negative screening’). Others seek investments in companies which have high social or environmental standards or performance (‘positive screening’).
Mainstream investors have increasingly adopted RI. An approach often employed is ‘engagement’, where investors seek to influence corporate behavior for the better. This might be by one-on-one meetings with companies, by participating in collective engagement with other investors, and/or by actively voting at shareholder meetings.
Another mainstream approach is ‘ESG integration’. This is where investors integrate an analysis of ESG factors into their investment decision-making to make better investment decisions.
There is a large and growing body of academic research into the effectiveness of these various approaches. For instance, in their 2012 paper “Active Ownership”, London Business School emeritus professor of finance Elroy Dimson and his fellow researchers examined the effects of intensive shareholder engagements on ESG issues at major publicly-traded US companies during the decade to 2009.
The research found that these created shareholder value, with an average one-year excess return of 4,4%. There is a consensus that, at the least, ESG analysis helps investment managers to reduce portfolio risk.
In the main, RI has developed organically. A growing body of investors adopts its practices for either reputational or ethical reasons, or because they believe it can help protect or enhance shareholder value. This voluntary approach is perhaps best exemplified by the PRI. It has grown from the initial 50 signatories, managing assets of $4 trillion, to more than 1 200 signatories managing $34 trillion.
But regulators and politicians have also acted, and SA is in the vanguard. The preamble to the revised Regulation 28 of the Pension Funds Act, published in 2011, explicitly requires trustees to consider any factor that “may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance character”.
Moreover, the Code for Responsible Investing in SA (CRISA), while voluntary, encourages investors to incorporate sustainability considerations and active engagement in their analysis, investment decisions and asset ownership.
So how should trustees go about discharging their responsibilities under Regulation 28 and CRISA?
A first step is to formulate the RI policy. Trustees should consider the principles most relevant to their fund and its beneficiaries. Here, trustees can benefit from those who have gone before. The PRI has already collated examples of best practice from around the world. It has also published guidance for signatories about how to develop their own policies on RI, voting and engagement.
The next step is to engage with asset consultants and investment managers. Most pension funds outsource their investment management. In many cases, it will be the managers who are responsible for implementing the RI strategy. It’s important both that trustees understand their managers’ capabilities and that managers understand trustees’ expectations.
The PRI is ready to help trustees and managers with policy formulation, advice on voting and how to approach engagement. Our clearing-house service has developed a number of themes for in-depth collaborative engagement with companies. There are clear benefits to investors acting collectively on issues of concern, as we found with the recent success of a three-year engagement on bribery and corruption risk.
We have also produced a guide to help pension funds incorporate ESG factors into their selection of investment managers. As well as suggesting some questions trustees might ask, and principles they might seek to follow, the report also presents a number of real-world case studies.
Becoming a more responsible investor is not a trivial undertaking. It involves thought, research and understanding. We strongly believe that an appreciation of ESG issues is vital to protect the long-term interests of pension fund beneficiaries, and often their short-term interests too. RI is simply about being a better investor.