The ESG conundrum for retirement funds
SA’s “record unemployment rate surges to the highest in the world”, was a sobering headline this week. A flawed education system and rigid labour laws are among the factors put forward to explain the unemployment powder keg.
According to most analysts, the blame and answer lie solely with the government. But we also need to consider the contribution of other role players, specifically that of the retirement fund industry.
Over the past 10 years financial markets, investors, and economies have witnessed a dramatic rise in socially responsible investing (SRI). This investment process combines financial objectives with concern about environmental, social, and governance (ESG) issues.
No-one wants to invest in anything that is morally irresponsible. But people also want to make money. The two are not mutually exclusive; many studies have shown that portfolios incorporating social objectives can still deliver competitive returns. SA investors can target dual goals through their investments — good investment returns and social factors such as poverty reduction.
Retirement funds, and by implication retirement fund members, have an essential role to play in the alleviation of SA’s social ills. In the same way, though the primary duty of retirement funds is to fund their obligations to beneficiaries, fulfilling these dual objectives will depend on their role as owners of companies.
The recent spate of civil unrest and the impact on companies have demonstrated that retirement fund members cannot afford to bury their heads in the sand. Social factors as we have seen can lead to decimated investment returns, and socially responsible investing is critical.
Asset managers worldwide have developed comprehensive frameworks to incorporate and evaluate ESG factors when making investment decisions. However, the implementation of SRI in SA is unlikely to be effective in dealing with social factors such as poverty reduction for two main reasons.
First, most investors may simply be chasing “feelgood” returns — that is, feeling good about supporting desirable activities rather than from any tangible benefit of making significant change. The good feeling associated with SRI is considered similar to the fun of participation that some gamblers may derive from playing in a game of chance.
The fun of participating in such a game generates more utility than would be derived from the financial return on the gamble. In the same way, some studies have found that the most likely reason for implementing SRI is “because it won’t look good if I don’t”.
Some global surveys have even questioned the validity of the responses to this question (is SRI essential?) because of the desire of those polled to respond in a politically correct fashion and not necessarily putting their money where their mouths are.
Therefore, though investors may be motivated by both return targets and social objectives when making investment decisions — the social factor is likely to be the least important.
Second, there is an element of Johnny-come-lately in implementing SRI, mainly when it concerns emerging market economies such as SA. European countries initially adopted SRI to compete with other countries and support shared goals of economic growth (this focus has since shifted to climate change factors).
Between 2000 and 2003, the European Social Investment Forum (EuroSIF) created a toolkit to guide institutional investors in implementing socially responsible investing.
Coincidentally, at the same time, the European Commission had formed a “Social Policy Agenda” to create new and improved jobs. SRI was used to mobilise support towards common European objectives — making Europe the most competitive economy capable of sustaining economic growth with more and better jobs and greater social cohesion.
It is perhaps unfortunate that a consequence of centralising the SRI agenda at a global level is that factors such as poverty reduction and job creation are not a priority. These factors are critical for sustaining long-term investment returns in SA.
Are retirement funds owners of companies or speculators in shares? The typical speculator generally wants to invest in shares to make a profit. Many do not want the administration and responsibility that come with ownership. With the rise of SRI, “maximisation of shareholder value” is now more consistent with the interests of a speculator and not of an owner.
Retirement funds must act like owners if they are to carry out their mission, not regarding speculation but long-term investing. This will require retirement funds as owners to exert a greater focus on social factors and the utilisation of SRI to support the shared goals (with government) of economic growth.
Studies conducted after the Arab Spring — uprisings that spread across much of the Arab world in the early 2010s — indicate that SA is a fertile breeding ground for social unrest. This is because of the exceptionally high youth unemployment rate.
Just imagine that investors continue to ignore this fact, palming off the responsibility to the government while having spotless ESG checklists. In that case, their long-term investment returns will be anything but sustainable.