ETH­I­CAL IN­VEST­ING: WHY IT PAYS TO BE NICE

As re­spon­si­ble in­vest­ment prac­tices gain trac­tion in South Africa and glob­ally, in­creased share­holder ac­tivism is likely to see CEOs and chief op­er­a­tional of­fi­cers called to pub­licly an­swer tough ques­tions around man­age­ment and in­vest­ment de­ci­sions.

Finweek English Edition - - FRONT PAGE - By Natalie Greve

alit­tle over two decades since the list­ing of South Africa’s maiden re­spon­si­ble in­vest­ment (RI) fund, eth­i­cal, so­cial, en­vi­ron­men­tal and so­cioe­co­nomic con­sid­er­a­tions ap­pear to be play­ing an es­ca­lat­ing role in the de­ci­sion-mak­ing process of mon­eyed in­sti­tu­tional and in­di­vid­ual in­vestors.

Re­sist­ing cus­tom­ary ad­vice that calls for the sep­a­ra­tion of sen­ti­ment and in­vest­ment judg­ments, in­vestors are opt­ing to sup­port funds that demon­strate a cer­tain cor­po­rate con­science – and it ap­pears this ap­proach may in­creas­ingly be mak­ing busi­ness sense.

Ac­cord­ing to Suzette Viviers, a pro­fes­sor in the de­part­ment of busi­ness man­age­ment at Stel­len­bosch Univer­sity, who has un­der­taken ex­ten­sive re­search on the sub­ject, on bal­ance, the riskad­justed re­turns from RI funds per­form on par with con­ven­tional funds; even out­per­form­ing them in cer­tain cases.

“It makes in­tu­itive sense that com­pa­nies which proac­tively man­age en­vi­ron­men­tal, so­cial and gov­er­nance (ESG) risks are go­ing to avoid fines, car­bon taxes, have more mo­ti­vated em­ploy­ees and more loyal clients – who may even be pre­pared to pay pre­mi­ums for greener prod­ucts and ser­vices.

“If they place pres­sure on sup­pli­ers across the sup­ply chain to fol­low their

lead, it can only lead to im­proved re­turns. This might also ex­plain the grow­ing in­ter­est in ESG in­dex­ing,” she com­ments.

RI, on the one hand, al­lows in­vestors to in­vest ac­cord­ing to the tenets of their be­liefs or ethics, em­ploy­ing a sel­f­ref­er­en­tial frame­work and tak­ing a stand on what they do not want to own. This form of neg­a­tive screen­ing is de­scribed as “eth­i­cal in­vest­ing”. (See box.)

As such, in­vestors re­frain from in­vest­ing in com­pa­nies that pro­duce “un­de­sir­able” prod­ucts or ser­vices, such as al­co­hol, tobacco, gam­bling and pornog­ra­phy, or com­pa­nies op­er­at­ing in “un­de­sir­able” in­dus­tries, such as nu­clear en­ergy and de­fence, and in “un­de­sir­able” coun­tries.

In the South African con­text, about a fifth of funds that were cre­ated be­tween 1992 and 2012 can be clas­si­fied as eth­i­cal funds.

In­vestors that ap­ply purely RI strate­gies, on the other hand, are typ­i­cally mo­ti­vated by a de­sire to im­prove ethics and cor­po­rate so­cial re­spon­si­bil­ity and en­sure fair labour prac­tices within the com­pa­nies in which they in­vest. (See graph.)

“Most RI fund man­agers fo­cus on so­cial is­sues. Of late I have also no­ticed an in­creas­ing fo­cus on en­vi­ron­men­tal is­sues, par­tic­u­larly those cen­tring on cli­mate change mit­i­ga­tion. I think the fo­cus on so­cial in­fra­struc­ture devel­op­ment should re­main, but more at­ten­tion should be given to en­vi­ron­men­tal con­sid­er­a­tions, es­pe­cially wa­ter. As far as I’m aware, very lit­tle at­ten­tion is be­ing given to this crit­i­cally im­por­tant re­source in South Africa,” she ad­vances.

RE­SPON­SI­BLE IN­VEST­MENT PRIN­CI­PLES

Lead­ing the charge for RI, the United Na­tions-backed Prin­ci­ples for Re­spon­si­ble In­vest­ing (PRI), launched in 2006, lays out a vol­un­tary and as­pi­ra­tional set of in­vest­ment prin­ci­ples that of­fer a menu of pos­si­ble ac­tions for in­cor­po­rat­ing ESG is­sues into in­vest­ment prac­tice.

The PRI finds lo­cal ap­pli­ca­tion through the Code for Re­spon­si­ble In­vest­ing in South Africa, or CRISA, which pro­vides guid­ance on how the in­sti­tu­tional in­vestor should ex­e­cute in­vest­ment anal­y­sis and ex­er­cise rights so as to pro­mote sound gov­er­nance.

CRISA ap­plies to in­sti­tu­tional in­vestors such as pen­sion funds and in­surance com­pa­nies as the own­ers of as­sets, as well as their ser­vice providers, in­clud­ing as­set man­agers and con­sul­tants.

“The code aims to put in place the checks and bal­ances needed to make this vol­un­tary frame­work suc­cess­ful. As long-term in­vestors with fidu­ciary du­ties, we sim­ply can­not af­ford to ig­nore the im­por­tance of in­te­grat­ing sus­tain­abil­ity is­sues, in­clud­ing ESG, into long-term in­vest­ment strate­gies. As in­sti­tu­tional in­vestors we have the abil­ity to in­flu­ence and en­cour­age the com­pa­nies in which we in­vest to ap­ply sound gov­er­nance prin­ci­ples and to care for the en­vi­ron­ment in which they op­er­ate,” com­ments CRISA chair­per­son John Oliphant.

PAR­A­DIGM SHIFT

The suc­cess of ac­tive, re­spon­si­ble in­vest­ment, he tells fin­week, re­quires a par­a­digm shift in the man­ner in which share­hold­ers per­ceive their power of in­flu­ence over the in­vestee com­pa­nies.

Oliphant likens the re­spon­si­bil­i­ties of an in­sti­tu­tional in­vestor in an in­vestee com­pany to that of a home­owner.

“As an in­sti­tu­tional in­vestor, you need to ac­cept that you own a por­tion of a com­pany. If you buy a house, you need to do main­te­nance, be cor­dial with your neigh­bours and pay mu­nic­i­pal bills – you have cer­tain re­spon­si­bil­i­ties,” he as­serts.

“The same is true for in­sti­tu­tional in­vestors. Re­spon­si­ble in­vest­ing, by its na­ture, re­quires in­sti­tu­tional in­vestors to demon­strate an ac­cep­tance of own­er­ship re­spon­si­bil­ity in the com­pany in which they hold shares.”

He fur­ther calls for the cog­ni­tion of chang­ing own­er­ship struc­tures in the South African economy that have swung ma­jor­ity own­er­ship of JSE-listed com­pa­nies into the hands of the work­ing class.

“There is a new wave of own­er­ship. Many years ago, com­pa­nies were owned by wealthy fam­i­lies, such as the Op­pen­heimers. These com­pa­nies are now es­sen­tially owned by the work­ers who are mem­bers of pen­sion funds, but the ex­ist­ing sys­tem of gov­er­nance has failed to recog­nise this.

“We need a par­a­digm shift in share­holder ac­tiv­i­ties that awak­ens the sleep­ing gi­ants [the work­ers], who are the real own­ers of the com­pa­nies. The de­bate around in­equal­ity can also be changed if share­hold­ers re­alise that they have a say,” Oliphant ar­gues.

This re­quires en­hanced mech­a­nisms through which prov­i­dent and pen­sion fund mem­bers can col­lec­tively en­sure that trus­tees re­main ac­count­able and that the mem­bers’ will is ex­er­cised.

SHARE­HOLDER AC­TIVISM

Re­spon­si­ble in­vest­ment ef­forts in SA have also been known to take the form of ro­bust share­holder ac­tivism, in which an in­vestor lever­ages pub­lic or pri­vate mech­a­nisms to raise their con­cerns around the gov­er­nance of the in­vestee com­pany to ini­ti­ate change.

Known to evoke the dis­con­tent of many a listed firm, share­holder ac­tivists com­monly call at­ten­tion to per­ceived poor gov­er­nance or fund man­age­ment in a pub­lic fo­rum, pub­licly call­ing of­ten vis­i­bly un­com­fort­able CEOs and chief fi­nan­cial of­fi­cers to ac­count for ques­tion­able de­ci­sion-mak­ing.

Pub­lic mech­a­nisms in­clude the fil­ing of share­holder res­o­lu­tions, ask­ing ques­tions at AGMs, vot­ing against res­o­lu­tions and stim­u­lat­ing pub­lic de­bate on is­sues of con­cern.

This form of share­holder in­flu­ence is par­tic­u­larly noisy in a coun­try such as SA, where there re­mains a strong pref­er­ence for pri­vate ne­go­ti­a­tions be­tween in­vestors and in­vestee com­pa­nies.

Pri­vate ef­forts to ini­ti­ate changes to cor­po­rate poli­cies and prac­tices in­clude writing let­ters, en­gag­ing in pri­vate ne­go­ti­a­tions, ini­ti­at­ing le­gal pro­ceed­ings, and usu­ally, as a last resort, di­vest­ing, says Viviers.

Hav­ing ex­ten­sively re­searched lo­cal share­holder ac­tivism, Viviers ex­plains that an in­di­vid­ual share­holder can have no­table in­flu­ence on the in­vestee com­pany if the ac­tivist has a clear goal,

An in­di­vid­ual share­holder can have no­table in­flu­ence on the in­vestee com­pany if the ac­tivist has a clear goal, re­searches the com­pany thor­oughly prior to the AGM, holds nor­ma­tive power and ex­hibits in­di­vid­ual, prag­matic and so­ci­etal le­git­i­macy.

re­searches the com­pany thor­oughly prior to the AGM, holds nor­ma­tive power and ex­hibits in­di­vid­ual, prag­matic and so­ci­etal le­git­i­macy.

“He or she should also be as­sertive and be will­ing to ap­ply his or her own re­sources. While I can un­der­stand that in­vestors want to pre­serve re­la­tion­ships with in­vestee com­pa­nies, the prob­lem with pri­vate ac­tivism is that it is too opaque.

“Other share­hold­ers and lenders who can’t ac­cess man­age­ment due to their size are left to­tally in the dark as to which is­sues are raised, how man­age­ment re­sponds to these is­sues, whether man­age­ment un­der­takes to trans­form and whether they are held ac­count­able for mak­ing good on their prom­ises,” she as­serts.

THE ‘BOTHA ST­ING’

De­spite claims that share­holder ac­tivism can as­sist in the ac­cel­er­a­tion of lo­cal so­cioe­co­nomic trans­for­ma­tion, Viviers be­lieves the South African mar­ket may not yet be pre­pared for the pub­lic ac­tivism ap­proach.

Prom­i­nent South African ac­tivist share­holder Theo Botha first pur­sued this tack in 2002 af­ter dis­cov­er­ing that life in­surance firm The Sage Group, in which he had in­vested, was post­ing con­sid­er­able losses in the US that it re­fused to dis­close to its South African share­hold­ers.

Af­ter Botha re­ported this to the JSE and dis­sem­i­nated the in­for­ma­tion to the press, the com­pany’s share price took a knock and it was sub­se­quently delisted from the lo­cal bourse be­fore be­ing ac­quired by Mo­men­tum in 2004.

Botha has since taken on sev­eral listed be­he­moths and has of­ten found him­self an un­wel­come guest at many an AGM.

Ac­cord­ing to a study by Viviers, a quar­ter of all is­sues raised by Botha cen­tred on re­mu­ner­a­tion, par­tic­u­larly around the lack of clar­ity on re­mu­ner­a­tion pol­icy; a jus­ti­fi­ca­tion of the size and com­po­si­tion of re­mu­ner­a­tion pack­ages in light of poor fi­nan­cial per­for­mance; a fail­ure to link pay to per­for­mance; and the faulty re­port­ing of cer­tain pay­ments.

“His ef­forts in high­light­ing un­sat­is­fac­tory ac­count­ing, fi­nan­cial and ESG prac­tices have earned him a rep­u­ta­tion as a cor­po­rate watch­dog – a ‘ter­rier’ to be more spe­cific. The so-called ‘Botha st­ing’ has been shown to re­sult in a sig­nif­i­cant de­crease in the tar­get com­pany’s share price di­rectly af­ter his pub­lic crit­i­cism,” she as­serts.

Although most share­holder ac­tivism in South Africa takes place be­hind closed doors, there seems to be a grow­ing aware­ness among as­set own­ers and man­agers of the im­por­tance of en­gage­ment, Viviers adds, much to the cha­grin of com­pany ex­ec­u­tives with a predilec­tion to­wards no­tions of in­de­pen­dence.

Suzette Viviers Pro­fes­sor in the de­part­ment of busi­ness man­age­ment at Stel­len­bosch Univer­sity

John Oliphant Chair­per­son of CRISA

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