How do you answer the questions around ESG, especially in the South African context where some imperatives loom larger than others?

By Phakamisa Ndzamela

The commitment of retirement funds and their trustees to implementing ESG principles is under the spotlight, as investee companies increasingly battle with how to juggle environmental issues, social inequality and governance.

ESG — shorthand for Environmental, Social and Governance — has become an indispensable part of the investment lexicon and an essential prism through which retirement funds, asset managers, and capital allocators assess the non-financial performance of companies into which they put their money.

But if that all sounds easy, it isn’t.

In July, The Economist highlighted numerous contradictions in ESG policies, labelling it an “unholy mess” in need of streamlining.

The magazine described how this movement often has conflicting imperatives: for example, while closing a coal mine is good for the environment, it is just as bad for jobs and suppliers. Equally, how can you build a wind farm without damaging the surrounding environment?

And, while Elon Musk’s record of corporate governance is disastrous, as co-founder of the electric carmaker Tesla, he is also fighting climate change.

For The Economist, all of this illustrates why ESG is flawed and risks “setting conflicting goals for firms, fleecing savers and distracting from the vital task of tackling climate change”.

In a sense then, one element of ESG must be prioritised and, for The Economist, this is the environment: the biggest danger to society comes from the emissions of carbon-spewing industries, like coal.

You can understand that. But in our eyes at Today’s Trustee, there is no trade-off necessary between fighting for climate change, and advocating for good governance. Someone who fights for climate change doesn’t have to be flawed when it comes to corporate governance. No transition happens without some complications — but this is no reason to avoid trying altogether.

Nonetheless, as a mirror of society, The Economist’s ESG critique should be taken seriously, as it does reflect the tête-à-tête among certain executives, however flawed these discussions may be.

So the question is, how do we resolve these conflicts? This is harder to answer in the South African context, where some imperatives loom larger than others.

This suggests that for retirement funds to preserve value, local trustees daren’t prioritise one pillar of ESG at the expense of another.

Forgetting about society

Take the “S” in ESG. Here, we have the social challenges of unemployment — a 33% unemployment rate, and 60% among the youth — which is an immense problem for political stability. To ignore this is to ignore a major social risk to long-term value in retirement funds. And yet some companies don’t consider this, just as they ignore diversity in their leadership and supply chains.

Governance, too, can often seems like a soft issue, but you only need to look at the fallout at Steinhoff, EOH and Tongaat-Hulett to realise the consequence of ignoring issues like board independence.

Aeon Investment Management, a Cape Town based boutique investment management firm managing R18bn in retirement funds, believes the “S” in ESG has often been neglected here at home.

Aeon’s CIO Asief Mohamed believes a deeper understanding of a company’s socio-economic impact on its employees and its environment usually leads to more sustainable and responsible investment decisions.

To drive ESG, Aeon has integrated its social policy into its investment philosophy, and tries to identify companies in which to invest that have a positive effect on society.

For example, it takes into account a company’s track record in creating jobs, its labour practices, gender pay equality, pay ratios, corporate social investment, as well as black ownership and management control.

“Good ESG reduces the equity risk premium, and, by implication, the cost of capital of companies — including in state owned entities and governments — in the long term,” says Mohamed. “We have a fiduciary duty on behalf of retirement fund members to produce, in the long run, the best possible risk-adjusted returns.”

Giving the shrinking universe (see the article on JSE delistings in this edition), Mohamed says it’s critical that asset managers try to influence boards to improve their ESG practices.

“We view reducing inequality and sustainable inclusive transformation as part of the ‘S’ in ESG, and we believe that all entities in SA should focus on this, as it impacts their long-term sustainability and profitability,” he says.

This is why, he argues, racial diversity in management and supply chains matters, since it creates a more stable and sustainable society.

But do companies with stronger ESG performance perform better financially?

Here, the evidence is equivocal. Mohamed says there’s no empirical data to support this, even though it seems intuitive that a diversified supply chain, for example, would help companies get better prices, and thus reduce their costs.

Implementing proper ESG policies doesn’t come cheaply, however. For example, to build a more diverse management team, you often need to invest in training or sell shares to historically disadvantaged people at a price which can dilute existing shareholders.                                                                        

But, Mohamed argues, the cost of not doing this is greater. “If this is not done to move to a more inclusive society, we may have a bloody revolution, and possibly a failed state,” he says.

Driving change through proxy voting

Mianzo Asset Management, a black asset manager based in Cape Town with R13,3bn in institutional assets and R306m in retail assets, says retirement funds ought to provide greater support for emerging black asset managers.

This could take the form of incubation programmes, which help build operational capacity. “These types of programmes are able to catapult transformation and bolster efficient growth,” it says.

Still, a debate that must be had is the extent to which black asset managers invest in black-owned and controlled businesses. Some critics feel these asset managers, when given the chance, resist investment in black-owned entities.

Mianzo notes that it tries to drive transformation through its proxy voting at companies in which it invests. It concedes its influence is still minimal, but that doesn’t stop it from actively engaging the management of those companies.

“The company’s response affects our choice of whether we invest [and] also affects the amount of capital we would invest,” it says. “Normally companies that score poorly on ESG will be classified as non-quality business and that limits the amount of capital we would be willing to invest.”

Mianzo argues that diversified companies are in a better position to do business, including when it comes to winning new contracts.“Retirement funds need to lead the way when it comes to ESG investing,” it insists. “We can’t forget that in SA, there are still communities that have not fully transformed and embraced diversity — all of us come from different communities.”