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InPerspective Spring 2019

ESG: tackling the big issues

15 October 2019
Author: Nazmeera MoolaHead of SA Investments

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 people smoking on the street are now frowned upon.

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. Ten-odd years later, and 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. Over the last few years, asset owners globally have progressed in this area. Most recently, we have seen the rise of a number of large asset owners excluding coal from their mandates. The result is that companies like Anglo-American are looking to divest from their coal assets.

Phase two 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 like business strategy and competitive strengths into their company analysis. In the last decade, and particularly in the last five years, they began to also include assessments of ‘softer’ areas like labour practices, environmental practices and governance.

The impact of concerns in areas such as these is now included in either cash flow projections or discount rates, which affect 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 impacting cash flows. Sibanye Gold experienced a number of safety incidents in early 2018, which led to 23 miners tragically passing away. Investec Asset Management was a significant shareholder of the company at the time, and we engaged repeatedly with company management. The business 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 South Africa, 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, like global debt.

The third phase of evolution has been the increasing sophistication of the engagement process. In 2011, Investec Asset Management formed the Investment Governance Committee, which is chaired by one of the Co-CIOs. Initially, this committee dealt with proxy voting and the engagement around that. However, the emphasis has increasingly shifted from reactively focusing on proxy voting, to a proactive engagement on critical issues that a company faces.

In South Africa this is particularly important as Investec Asset Management is the largest manager of third-party assets. The narrow SA market means that we cannot opt to sell or ignore every problem company. Importantly, engagement does not only focus on ESG issues, but on the strategic business issues that 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.

In summary, 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, Investec Asset Management is 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. There is still much to be done, as data becomes more standardised in areas like carbon disclosure and safety records. This will help better facilitate the integration into company valuations.

Engagement is one of the most powerful tools we have as active investors. We currently focus our engagement on our larger holdings as we believe we can have more impact this way. Of course, we highly value asset owners’ views on our approach to engagement as we are on this journey together. We continuously look at ways to refine our investment process and how best to equip our analysts to get the most from their engagement with companies so that we can deliver the best outcomes to clients.

Nazmeera Moola
Nazmeera Moola Head of SA Investments

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All information provided is product related and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Past performance is not necessarily a guide to future performance. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. We endeavour to provide accurate and timely information, but we make no representation or warranty, express or implied, with respect to the correctness, accuracy or completeness of the information and opinions. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate. Any representation or opinion is provided for information purposes only. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management (Pty) Ltd is an authorised financial services provider. Issued by Investec Asset Management, October 2019.

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