Environmental, social and governance abuses are the new tobacco
The narrow SA market means we cannot opt to sell or ignore every problem company
It is always surprising how quickly attitudes change. When I was at university, cigarette companies produced sexy advertisements showing beautiful people skiing or sailing while smoking. Fast forward to 2019 and even people smoking on the street are now frowned on.
In 2008 environmental, social and governance (ESG) issues were seen by many in financial markets as, at best, a good marketing angle, or at worst a waste of time. Now conditions have shifted dramatically.
The first phase of integration involved screening out prohibited stocks or sectors. Certain stocks or sectors (for example arms manufacturers) were excluded from investment mandates. In recent years asset owners globally have progressed in this area. Most recently we have experienced the rise of a number of large asset owners excluding coal from their mandates. The result is that companies such as Anglo-American are looking to divest from their coal assets.
Engagement does not only focus on ESG issues but on the strategic business issues a company faces. We view ourselves as active shareholders
The second phase evolved over several years but has resulted in the integration of ESG considerations into the investment process. Analysts and portfolio managers have long recognised the value of including assessments of non-accounting information such as business strategy and competitive strengths into their company analysis. In the past decade, and particularly in the past five years, they began to include assessments of “softer” areas such as labour practices, environmental practices and governance.
The effect of concerns in areas such as these is now included in either cash flow projections or discount rates — thus there is a tangible impact on company valuations. This makes sense, as these soft issues can have a hard financial impact.
A good example is the mining industry, where a poor safety record can result in accidents and stoppages, thus dramatically affecting cash flows. Sibanye Gold experienced a number of safety incidents in early 2018 that led to the deaths of 23 miners. Investec Asset Management was a significant shareholder of the company at the time, and we engaged repeatedly with company management. The company performed a deep overhaul of its approach to safety, resulting in a material improvement in mine safety in the period since. There have also been far fewer work stoppages, thus improving the productivity and profitability of its operations.
In SA the integration of ESG assessments into financial metrics has been heightened by recent governance failures, most notably Steinhoff. While it is always difficult for public market investors to detect fraud, we have tried to better identify the warning signals — for example, low earnings to cash flow conversion rates. In addition, asset owners are increasingly requiring asset managers to have integrated ESG processes that deal better with ESG concerns. At times, these requirements extend to unexpected mandates, such as global debt.
The third phase of the evolution has been the increasing sophistication of the engagement process. In SA this is particularly important because Investec Asset Management is the largest manager of third-party assets. The narrow SA market means we cannot opt to sell or ignore every problem company.
Engagement does not only focus on ESG issues but on the strategic business issues a company faces. We view ourselves as active shareholders. These are the responsibilities we have as key shareholders:
- Actively consider all pertinent factors, including the long-term impact of company strategy, balance sheet decisions, labour and safety practices.
- Have a clear understanding of what we would like rectified when we enter into engagement with a company. What is our goal from the engagement?
- Engage management actively when we have concerns, with a view to eliciting change.
- Escalate engagement if we are not being heard.
Engagement is one of the most powerful tools we have as active investors. The aim of our engagement work is to help preserve and grow the real value of the assets entrusted to us by our clients over the long term. To aid this we are intent on ensuring boards of companies focus on the creation and preservation of sustainable value.
Investing client capital into an uncertain future requires the investment capability to include governance as part of the fundamental analysis process.
While smoking has moved from glossy advertisements to the dirty secret you hide from your friends, ESG and engagement have not only become fashionable but are increasingly part of the investment analysis bedrock.
• Moola is head of SA investments for Investec Asset Management.