24 Jan 2018
Johan Gouws – Head of Institutional Consulting at Sasfin Wealth
Environmental, Social and Governance (ESG) considerations are increasingly becoming part of the agenda for trustees when it comes to retirement fund investment strategies. While the main objective of ESG primarily relates to social responsibility and sustainability, in the long-term it also presents the opportunity for exploring alternative investment opportunities that can result in greater investment risk management and enhanced investment portfolio returns. Recent studies have shown that active shareholder engagement by asset managers on behalf of institutional investors, such as retirement funds, are forcing company executives to adopt a more strategic approach in how they conduct business. This shift in focus is not only resulting in long-term business outperformance, but also in more value created for investors as well as enhanced investment returns and retirement fund benefits for members.
The responsible investment consumer
Households and consumers are becoming increasingly aware of their purchase and behaviour when it comes to concerns about environmental and ethical considerations. For this same reason there is no excuse for retirement fund members not to challenge the trustees of retirement funds regarding their approach to responsible investing. Various frameworks and codes are compelling retirement fund trustees to consider ESG matters when awarding portfolio mandates and monitoring mandate compliance and investment performance. Retirement funds provide the perfect vehicle through which social responsible investing can be achieved given the long-term nature of their investments. As the largest asset owners in South Africa they potentially also carry the most power in influencing the behaviours of government and corporate entities. Currently this power is not fully utilised given the focus on short-term investment returns, a lack of trustee knowledge on the subject and the inability to value the positive contribution of ESG on investment performance and towards society as a whole.
One of the main reasons for why ESG has not been at the top of the agenda for retirement fund trustees have been the inability of asset managers to show the direct correlation between ESG considerations and the positive contribution to investment returns. As a result, many trustees still hold the view that ESG considerations are in most cases incorporated into investment decisions at the cost of investment performance. Such a dualistic approach ignores the fact that superior and sustainable investment returns can only be achieved within a sound financial and economic ecosystem.
ESG ultimately results in improved risk management and forces management of companies to think more strategically about the future. This leads to the more responsible use of scarce natural resources, the development of human resources, higher productivity, greater company profitability and ultimately superior returns on capital. A recent study published in the Harvard Business Review found that companies that are managed with a long-term value focus consistently outperforms their peers over time. New industries related to environmentally friendly products and services are also providing for attractive investment opportunities and alternative sources of portfolio diversification.
Consulting on best practice
Asset consultants of retirement funds have a critical role to play in aligning the interest and the actions of the asset owners and the asset managers to whom investment mandates are awarded. Asset consultants need to articulate the need for incorporating ESG considerations into the purpose and objective of retirement funds as part of their Investment Policy Statement (IPS). Specific reference needs to be made to the introduction of the King IV Code on Governance in South Africa that was issued on 1 November 2016. The code requires that retirement funds implement a policy on the incorporation of sustainability considerations. In addition, the IPS need to state that account is taken of the Code of Responsible Investing in South Africa and FSB Circular PF130 in pursuing the objectives of King IV. The asset consultant should also assist retirement funds with investment mandate designs and portfolio construction that will allow the funds to meet their long terms objectives, but not at the cost of society and the environment. Asset consultants need to closely monitor and report on the active steps that asset managers take on behalf of the retirement fund and what the results have been of these actions.
Sociopolitical stability, sound corporate governance, good infrastructure as well as investor and business confidence are all key requirements for sustainable economic growth. The growth required for members to be able to save and invest and create the necessary wealth required to retire financially independent. South Africa currently finds itself in a low-economic growth trap with high levels of debt, unemployment and inequality which together represents a material risk from a sociopolitical stability perspective. The fiduciary duties of trustees should not be limited to only protecting and advancing the financial interest of the fund members, but also includes a responsibility as stewards of retirement fund assets that must contribute towards securing the future of the broader South African and global investment and financial ecosystem.
Quality of life during retirement should not only be measured in financial terms, but also need to consider the safety, security and the stability of the environment in which retirement fund members will live during retirement. A sound investment strategy incorporating the consideration of and compliance with ESG principles needs to be measured not just by the value created through investment performance, but also the value created to society, the environment and for future generations.