Towers Watson Asset Manager Review

Quarter 1, 2015

How can retirement fund Trustees respond to regulatory and member pressure by incorporating general or specific ESG considerations into their funds’ investment strategies? Which responses do you believe would be most effective and constructive?

Karl Leinberger, CIO at CORONATION FUND MANAGERS

says as custodians of investors’ long-term capital, the sustainability of any investment is a key consideration, which includes a thorough analysis of ESG factors.

“Boards of trustees should, however, be careful not to overreach when it comes to ESG factors as these factors should not be considered in isolation; they form an intrinsic part of the mosaic of any particular investment case. Outsourcing the proxy voting process to a third party also needs to be approached with caution, as this could result in unintended consequences such as box-ticking.”

Leinberger says when conducting a due diligence or interrogating an investment process or philosophy, boards of trustees should ensure that the investment manager has the following in place with respect to ESG: Some form of sustainability report, detailing the manager’s approach to ESG, both as a business and as an active owner; Application of a well-considered proxy voting policy; Availability of proxy voting to clients; Ability to demonstrate inclusion of ESG issues into their investment process; Ability to demonstrate that they are active owners by providing evidence of engagement with the companies in which they invest.

Rhy n h a r d t Roodt, portfolio manager at INVESTEC ASSET MANAGEMENT

results

says it is important for all stakeholders in the investment value chain, not only trustees, to recognise that responsible investment (RI), as communicated in the preamble to the amended Regulation 28, is situated within the context of the trustees’ fiduciary duties to act in the best interest of its members. And it is from this perspective RI should be considered.

“Training for the trustee around RI is an imperative as a first step to facilitating an appropriate response. This should include an understanding of the trustee’s fiduciary duties in the context of his particular fund.

“Secondly, as a board, trustees should attempt to identify the environmental, social, and governance issues which impact members directly and indirectly (for all time-horizons) as well as identify issues of particular importance to members. This should be simultaneous to developing an understanding of how ESG considerations may affect investment performance.

“This view should be integrated into the funds’ investment philosophies and communicated to consultants and asset managers, as well as reported on to the FSB, members, and the public as appropriate,” says Roodt.

says trustees can determine which components of corporate governance, environmental standards and stakeholder relations are important and then choose to invest in ethical solutions.

“They are able to take direct action by restricting their mandates or eliminating investments in companies based on the types of goods they produce (‘sin’ or damaging to the environment) or where there is a violation of ethics, thereby ensuring one does not invest in such activities.

“Asking managers to consider certain proxy voting guidelines – for example in line with the King III code can also be included. Another response is to take action in the form of shareholder activism whereby trustees can attempt to influence company actions through direct dialogue with management and/or voting at annual general meetings.

“The most beneficial and responsible response is to restrict investment in businesses with the most damaging material ESG issues such as carbon emissions, pollution, fair wages and health and safety concerns. The funds to these businesses can then be reallocated to those that meet higher ethical standards or invested in alternative industries,” says Manjoo.

Rob Lewenson, governance and engagement manager at OLD MUTUAL INVESTMENT GROUP

says it is important that Trustees understand their role as a “universal owner” as envisaged through legislation such as Regulation 28 and industry codes such as CRISA.

He believes the following trustee responses are the most effective and constructive in responding to the responsible investment agenda:

Trustees should seek to understand the broader sustainability landscape in South Africa and how this manifests in the reality of their members as a basis for building a commitment to addressing ESG issues in their fund vision and mission statements,

Trustees should understand the existing ESG risks in their portfolio via portfolio risk assessment along with a detailed assessment of the responsible investment practises of their appointed asset managers.

Trustees should work with asset consultants that have a deep understanding of responsible investment practises and ESG issues in order to integrate responsible investment considerations in their investment strategy. This could include hedging of carbon risk through low carbon investments, seeking low-cost ESG risk mitigation through index products and/or directing funds to unlisted assets that address key sustainability issues (such as housing, infrastructures schools and agriculture). It is

Theme:

Questions for fund managers: important to understand that such allocation should not be undertaken on the basis of a return sacrifice.

Trustees should integrate responsible investment criteria into the fund mandate with asset managers as well as provide feedback to members on responsible investment practises of the fund.

Mark Cliff at PSG ASSET MANAGEMENT

says it is important for trustees to have a relationship with an asset manager who appreciates the socio- political environment within which the trustees are expected to operate.

“As trustees are stewards of their members’ capital, so the asset manager becomes that steward when he is appointed to manage the assets. In as much as ESG considerations may have a limiting effect on investment performance from time to time, there needs to be sufficient understanding of this dynamic, and good faith between members, trustees and the asset manager.

“A manager who will forgo an otherwise attractive investment opportunity in the interests of ESG considerations should not feel that he will be “punished” for this later.

“The manager needs to make investments on behalf of the fund members that take proper account of all the responsibilities placed on trustees by both legislation and social expectation. The manager cannot do that without appropriate engagement with the management board of the entity in which he invests.”

Cliff says it would do a manager well to keep in mind that the onus of stewardship, which started with the trustees and was passed to him, is ultimately transferred to the management board of the company in which the fund is invested. A good manager of pension fund assets therefore does not “buy shares”; he “buys a stake in a business”, and must think like an owner of that business, and monitor management conduct accordingly.

Mahesh Cooper, GRAY

director at ALLAN

says the appointed trustees can fulfil their ownership responsibilities by vetting the asset managers they appoint to ensure that the asset managers appropriately incorporate ESG considerations into their investment processes – recognising that ESG issues are important drivers of investment value and that a failure to incorporate them can destroy investment value.

Cooper says trustees can question asset managers in this regard and appoint asset consultants to assist them in the screening and evaluation of asset managers.

Nadim Mohamed, investment analyst at First Avenue Investment Management

says the worst outcome possible would be for ESG considerations to be implemented hastily as a ‘box-ticking’ exercise in response to regulatory and other pressures.

“Our impression is that addressing ESG in this manner leads to ineffective outcomes. A superior approach would be for trustees to first develop a common set of principles guided by CRISA, UNPRI and the King III Report on Governance representing areas specifically of interest to the respective fund.

“This includes a formal acknowledgement of the importance of environmental, social and governance (ESG) factors and their impact on the long-term health and stability of the market and society as a whole. “Thereafter, the board of trustees need to determine how best to act upon these principles. This could be through the encouragement of integrated analysis of ESG factors within the investment process, active ownership (through proxy votes and engagement with management) and specific portfolio exclusions (for instance undesirable industries such as tobacco and alcoholic beverages).

Cora Fernandez, chief executive, institutional business at Sanlam Investments

says according to the 2015 Sanlam Benchmark Survey, 71% of stand-alone retirement funds have a responsible investing policy in place that incorporates ESG, however, the majority of these funds surveyed (51 percent) abdicated decisions on shareholder voting to the asset manager.

“Our experience in implementing such fund policies indicates that of ESG policies, the type most amenable to implementation is governance, so perhaps trustees could start there. One way to expedite policy writing is to request copies of the policies of their investment managers and adapt them to the requirements of fund beneficiaries.

“Implementation would be facilitated if trustees were to set out reporting requirements for their service providers. These policies and reporting requirements should eventually form part of the mandates and service-level agreements with service providers,” says Fernandez.

Nick Curtin at FOORD says the ESG

considerations referred to in the regulations are nothing new. As fiduciaries, both trustees and fund service providers should have always incorporated these basic principles of stewardship in their activities. It should form the foundation of the relationship when accepting the responsibility for taking care of members’ retirement fund savings.

“Sadly, the need for regulation in this area is another example of the many principal/agent problems that have beset the pension fund management industry.

“We do not see stewardship as a separate disaggregated piece of the investment management process. Rather, its sits at the heart of everything that we do.

“Trustees must ensure that their appointed service providers have embraced the substance of these considerations as opposed to adopting a tick box approach,” says Curtin.

Matt Brenzel at Cadiz

says trustees need to be very clear in their minds as to how prescriptive or hard-nosed they wish to be when it comes to incorporating ESG issues into their fund’s investment strategies. They also need to decide how informed they wish to be on the ESG matters of their fund’s assets.

Clearly, the local and international trend is for the inclusion of some form of guidelines; business is no longer “as usual”. So, where to start?

Brenzel says trustees should become familiar with the following in devising an in-house ESG standard: Code for Responsible Investing in South Africa (CRISA), which encourages institutional investors to integrate ESG into their investment decisions. King Report on Corporate Governance South Africa (King III). United Nations-backed Principles for Responsible Investment (PRI) initiative, the UN Global Compact and the Carbon Disclosure Project. South African Impact Investing Network. “Thereafter, the adopted code needs to be clearly communicated to the fund manager and related advisors. Further distinction could be added by requiring the fund manager to be a signatory to some of the above, to provide full details of proxy voting and to report back to the trustees on any interaction with corporates on ESG concerns,” says Brenzel.

Andrew Newell, head of business development at CANNON ASSET MANAGERS

says trustees and institutional investors (consultants and multi-managers) seem to have placed some emphasis on ESG factors, to different degrees.

“The various ESG considerations have been launched with the intention of promoting sound practices by the investment industry as well as placing sustainability at the forefront of investors’ minds.

“Incorporating these factors can be done either by allocating to explicitly mandated ESG products and portfolios, or by allocating to broader products in which the investment managers give direct attention to the factors that are under discussion.

“Ultimately, it will be demand from trustees that will shape the product offering of the industry. To this end, fund trustees will likely need to directly incorporate an element or minimum ‘exposure’ to ESGoriented investments in their investment strategy guidelines, which, in turn, will place the onus on the investment industry to demonstrate to what degree they are aware of or compliant with ESG considerations,” says Newell.

Mohamed Mayet, MD of SENTIO CAPITAL

says the South African market has treated ESG considerations as almost as incidental to other financial factors until recently. Perhaps with the exception of governance factors, which are seen to directly influence management performance, environmental and social factors are often relegated to the glossy annual report.

“This is probably due to the fact that financial performance is easily measured in the short-term, while ESG is seen as a ‘softer longer-term issue’. We believe that investors and their stewards need to see ESG as integral to financial performance before we see any real impact.

“The best and easiest way for this to happen is on two levels: companies need to be urged to include a ‘hard scorecard’ in management compensation considerations and investment managers need to ‘reward and punish’ listed companies based on these scorecards.

“Urging change at board level is of course more of a medium to longterm solution, we need to get the ball rolling in the near term through investors voting through the share price. For example, a polluter whose core business is integrally tied to CO2 is unlikely to change their business model overnight, but will pay attention to the share price.

“The only way to address it is to treat poor performers like you would for any other ‘hard-risk or financial measure’, all the way from boardrooms through to investment managers,” says Mayet.

Angelique Kalam, manager: sustainable investment practises at FUTUREGROWTH ASSET MANAGEMENT

says pension and provident fund trustees can respond to regulatory and member pressure by ensuring that the topic of responsible investing (RI) is on the fund’s agenda and forms an integral part of the strategy and how it’s managed.

“The first step is to ensure that the fund defines its RI objectives and outlines the focus areas. Funds need to take ownership and ensure that these principles are implemented according to their specific fund objectives.

“The RI objectives and purpose provide clarity for the service providers who are able to execute on the fund’s instruction. The consultants and investment managers are then able to provide meaningful feedback in terms of integrating these key principles, whether on a quarterly or annual basis as mutually agreed.

“It is time the industry moved from principles to actions: 1) Funds should ensure that ESG principles are embedded within their mandates as part of their fiduciary duty and engage their service providers on these matters; 2) Asset consultants should provide guidance in terms of best practice standards and provide services to evaluate these ESG processes: and, 3) Investment managers should demonstrate what integration of ESG issues means to them and provide practical examples during reportor due diligence feedback sessions,” says Kalam.