Companies embrace ESG, but closer scrutiny is key
• Investments offer significant opportunities for capital growth and returns
As more investors look to deploy capital to support their moral values or align with a purpose, asset managers are responding by incorporating environmental, social and governance (ESG)-linked investments in portfolios.
Importantly, in addition to meeting investor demands for socially-conscious or impact investing, ESG investments offer significant opportunities for capital growth and returns.
For example, climate transformation through decarbonisation and the journey to net zero is both an environmental imperative and an unprecedented growth opportunity for investors. According to estimates in the International Energy Agency Net Zero by 2050 report, renewable energy production could account for 90% of power generation by 2050.
However, achieving these targets would require an estimated $4-trillion in annual clean energy investment by 2030, which UN special envoy on climate action Mark Carney says represents “the greatest commercial opportunity of all time”.
Moreover, ESG considerations will impact a company’s ability to deliver adequate long-term cash flows and returns, believes Qhivi Tiva, Portfolio Manager at Prowess Investment Managers.
“Companies and investments that promote longer-term, sustainable thinking in terms of business strategy and promote a management culture that cultivates and rewards a sustainable way of doing business should, in our view, lead to long-term sustainable returns.”
And the opportunity set that ESG investments offer is not lost on investors. In a recent Refinitiv wealth report, 42% of polled investors chose positive performance as the primary reason for considering ESGlinked investments.
“In response, many asset managers are adjusting their investment philosophies to integrate ESG themes and approaches, with the majority becoming signatories and supporters of ESG bodies such as Crisa and Unpri,” says Tiva.
In the local context, ESGaligned investing can also play an important economic growth and developmental role due to failures by the state to build and maintain vital infrastructure and deliver the social functions for which it is constitutionally responsible.
“The debate around whether asset managers and corporates more generally should explicitly take social issues into account in terms of their investment decision-making is not without its controversy,” says David Crosoer, Chief Investments Officer at PPS Investments.
Crosoer believes corporate SA needs to play a role in tackling the challenges that currently plague society, particularly to fill the current vacuum left by the incumbent state.
“However, it is important to remain realistic about what the asset management industry and private sector can do to drive change and why the incentive structures are not necessarily aligned to resolving the many pressing social challenges that, in my view, are linked to state rather than market failure.”
According to Crosoer, the muddle that the asset management sector faces with regard to ESG, especially regarding the social element, is based on arguments around the obligation of the private sector to provide public goods with positive externalities in sufficient quantity, despite no incentive to do so.
“Often it is the state’s failure to legislate in response to pressing societal and environmental issues, rather than the response of private companies, that is at fault,” says Crosoer.
“However, understanding the incentives driving the undersupply of public goods with positive externalities, and that the broader asset management industry remains driven by profit and narrow self-interest, is an important starting point, especially in the South African context where the state has failed so spectacularly.”
Given the ineffectiveness of the state, Crosoer believes local organisations that can effectively embed ESG into their purpose, especially in the provision of public goods, will likely play an important role in shaping the country’s future.
“In this context, organisations focused on impact could look different from traditional asset management firms and the incentive structure that typically drives their behaviour.”
However, as the groundswell support for ESG grows, closer scrutiny of credentials will force a broader rationalisation within the asset management sector.
“ESG is going through a phase of consolidation where a number of very large global asset managers have recently pulled back on some of their initial commitments, and global regulators are cleaning up ESG funds that have turned out not to be as clean as advertised,” says Neville Chester, Senior Portfolio Manager at Coronation Fund Managers.
“Many funds have been declassified as ‘green’ after it became clear that they were using ESG as a marketing tool rather than a true driver of sustainability.”
Chester believes that the invasion of Ukraine also raised important questions around the speed at which the world can practically decarbonise, and what constitutes a good actor in the ESG ranking process.
To overcome the challenge posed by ‘greenwashing’, Tiva recommends better ESGrelated disclosures by companies and issuers.
“We also need standardised methodologies and metrics to reliably measure the impact,” he concludes.
IN RESPONSE, MANY ASSET MANAGERS ARE ADJUSTING THEIR INVESTMENT PHILOSOPHIES TO INTEGRATE ESG THEMES AND APPROACHES
HOWEVER, IT IS IMPORTANT TO REMAIN REALISTIC ABOUT WHAT THE ASSET MANAGEMENT INDUSTRY AND PRIVATE SECTOR CAN DO TO DRIVE CHANGE