ESG, impact investing and sustainability is a recent trend in the South African market that is particularly close to my heart. And I’m concerned that these concepts are not properly understood or being utilised appropriately and therefore are prone to manipulation. Let me explain…
It was through working with my co-founders of a private markets impact investment business in the Netherlands in 2020 that I learnt about the global experience of impact and private market investing. In short, many promises of great returns and positive impact in addressing some of the world’s major social and environmental changes had been made. Yet, despite paying significant fees in pursuit of that promise, limited results (performance yes, but impact in particular) had been delivered.
I’m sure you’ll remember that 2020 was “Covid time”! It was off the back of a heightened awareness and fear, that ESG became the new buzz word in South Africa. Everyone suddenly became ESG conscious, from consultants to asset managers, even some retirement funds.
That was the start of “the noise” in South Africa. ESG then has evolved into impact and sustainability now. Suddenly every man and his dog are offering a sustainable investment approach and impact products, publishing sustainability reports, have the UN SDGs plastered over their marketing material etc.
So, what is real and what is simply there to capture your imagination (and your money of course)? It all starts with understanding.
Understanding ESG
For those who don’t know, here is a definition of ESG and its importance courtesy of Chat GPT.
ESG stands for Environmental, Social and Governance. It refers to a set of criteria used to evaluate a company’s operations and performance based on its impact on society and the environment, in addition to its financial performance. ESG factors have become increasingly important in investment decision-making, corporate strategy and public policy.
Environmental (E)
This focuses on how a company manages and mitigates its environmental impact. Key factors include:
Carbon footprint: The amount of greenhouse gases a company emits.
Resource usage: How efficiently the company uses resources like water, energy, and raw materials.
Waste management: How well a company handles its waste, including recycling practices and disposal of hazardous materials.
Biodiversity: How a company’s operations impact ecosystems and wildlife.
Climate change: Strategies to address and adapt to climate-related risks.
Social (S)
This refers to the company’s relationship with employees, customers, suppliers and the communities where it operates. Key factors include:
Labour practices: Fair wages, employee benefits, workplace safety and workers’ rights.
Diversity and inclusion: Efforts to promote diversity in hiring and leadership, as well as fostering an inclusive work environment.
Human rights: Adherence to ethical standards, avoiding exploitation or abuse of workers, and ensuring products and services are ethically sourced.
Community engagement: Contributions to local communities, including philanthropy and involvement in social causes.
Customer relations: Ethical marketing practices, customer privacy protection and product safety.
Governance (G)
This addresses the leadership, structure, and governance policies of a company. Key factors include:
Board structure: Composition of the board of directors, including diversity, independence and expertise.
Executive compensation: How the company compensates executives, ensuring alignment with long-term shareholder value.
Shareholder rights: Transparency in corporate decision-making and the ability of shareholders to influence company policy.
Ethical business practices: Anti-corruption policies, transparency in reporting and adherence to legal standards.
ESG is a framework that helps evaluate the broader impact of businesses on the world. It has grown in importance as stakeholders, including investors, customers, employees and regulators, seek greater accountability and sustainability from corporations. It is also a great tool to assess risk in investment portfolios and the competency of investment managers.
So back to 2020… rather than shoo-shoo these latest trends, I decided to do a Harvard Business School on-line course in Sustainable Business Strategy where I learned that, when running a business, leadership should focus and have a clear strategy to add value to the 5 key pillars of what makes the business successful:
- Your shareholders;
- Your community and environment;
- Your staff;
- Your customer;
- Your regulator.
A well-managed business is one that considers multiple stakeholders (society, the environment, its employees, customers, regulators and shareholders) in defining and executing on its business strategy. The business is likely to grow earnings competitively and help develop an environment for sustainably superior growth. If you focus equally on adding value to all 5 stakeholders, you will develop a strong and sustainable business. If you consider the principles captured within ESG, they serve as a guide (not exhaustive) to do exactly that. It made total sense to me, and I was a convert.
In fact, in my opinion, this is the basis on which all retirement fund fiduciaries (trustees, manco’s and consultants) should go about creating their investment policy/strategy, assessing and selecting providers.
Retirement fund trustees and manco’s are uniquely positioned to influence a just transition to a more sustainable future for South Africa. Their fiduciary duty primarily demands an oversight to support members in their aim to financially retire comfortably. Lately, attention is also being directed to the social and natural environment that members will retire into. Financial security does not equate to a desirable retirement if the society and environment into which you retire, is dysfunctional.
So, what is sustainable investment?
Sustainable investment is investment that generates positive impact and /or reduces negative impact on the world, while at the same time seeking to maximise risk adjusted returns over the long-term, leading to sustainable benefits for investors, the economy, the environment and society. Return and sustainability are not mutually exclusive – one can generate sustainably strong investment returns and positive impact at the same time. When we think of sustainable investment, we think both of our generation’s needs, and those of future generations.
And what is impact investing?
Impact investing is similar to sustainable investment but has the added expectation of a pre-determined and measurable environmental and/or social outcome, for example, the number of long-term jobs created; quantifiable amount of greenhouse gas emissions reduced etc.
Sustainable investment versus ESG and impact investing
While sustainable investment can be thought of as an investment philosophy or approach, it does naturally capture many of the hard, and often exclusionary, rules and impact objectives that are embedded within typical ESG and impact investment mandates.
Hence, a sustainable investment approach provides us with the necessary lens to advise, and relevant ESG and impact considerations that can be adopted to provide the best outcomes.
The case for sustainability
Most of us invest money to ensure a better future for ourselves or our clients. It is an aspired future that promises livelihoods of comfort and societies that prosper.
Humanity’s ecological footprint – a measure of how fast we consume natural resources and generate waste compared to how fast nature can absorb our waste and generate new resources – is currently in a state of “ecological overshoot” annually consuming the equivalent of 1.6 planet earths.
Such consumption leads to inequality, not just in access to resources but also in access to opportunity and, by default, leads to inequality in wealth between individuals, generations, income groups and countries. This inevitably creates societal threats including excessive poverty, tax avoidance, political fundamentalism and manipulation of education systems.
Economic activity is often a driver of these inequalities, and the agents that operate within economic systems require external, independent and stringent analysis of, among other issues, the way they are governed, their contribution to a healthy and regenerative environment, the distribution of their wealth between employees and the security of long-term shareholder value.
These same companies operate within social contexts that have a profound impact on numerous stakeholders from suppliers and customers to regulators and surrounding communities. It is these relationships that provide companies with their social license to operate. If this license is damaged, shareholder value, too, is damaged.
As fiduciaries, it is imperative to ensure that sufficient scrutiny and expectation is placed on the recipients of your capital so ensure that investors can retire into a future that is sustainable and that future generations can enjoy the same quality of livelihood and fulfil their potential with sufficient supplies of resources and opportunity.
And if that isn’t enough…
Regulation 28 of the Pension Funds Act instructs retirement funds to consider environmental and social issues that materially affect long-term performance of assets. Very few assets will perform well in a degraded environment or malfunctioning society.
This is further supported by the FSCA Communication 1 of 2019, which provides guidance on how funds must apply Regulation 28 and, in particular, how investment policy statements should seek to ensure the sustainability of their investments and assets.
However, in a survey conducted by the FSCA and IFC (International Finance Corporation) in 2020, on Sustainable Finance Practices in South African Retirement Funds, it was found that retirement funds were unsure how to monitor sustainability across their funds and providers….
and did not know how to report on them.
Reporting on elements contained in the FSCA Guidance Notice 1 of 2019 relating to sustainability
Now maybe this has improved over the past 4 years but I have not seen much evidence of this. Fiduciaries need to hold themselves to higher account here and seek ways to play a more active and intentional role.
And also, please beware….. don’t fall for the promises of impact or the allure of sustainability without asking the right questions of those peddling well-packaged product.
And that quite simply is….
What are the targets and how do we measure it?
If it cannot be measured, it cannot be managed! It’s that simple.
