Towers Watson Asset Manager Review

Quarter 1, 2015

2How do you incorporate general or specific ESG considerations into your investment decision-making? If engagement with company management is part of your ESG strategy, do you believe this is effective?

Rhynhardt Roodt, portfolio manager at INVESTEC ASSET MANAGEMENTsays

as the company is a multi-investment philosophy and process house, there is no one standard ESG incorporation process. Rather, and more appropriately, ESG considerations are incorporated as best suited to the investment style and philosophy of each process. A consistently robust proxy voting process is applied across all equity holdings.

“Along with proxy voting, engagement is a fundamental component of ESG integration for all processes, for two primary reasons. Firstly, a constructively managed engagement process allows us to assess financial performance of particular stocks more accurately, and on occasion contributes to the investment decision making process.

“The second reason is to ensure the responsible conduct of a company of which we, on behalf of our clients, are part owners. There are many examples which demonstrate the effectiveness of engagement, sometimes leading to changes in portfolio positioning or greater conviction of a current position. A basic and typical example of an engagement topic, which meets the criteria of both materiality and responsible ownership is management remuneration,” says Roodt.

Fazila Manjoo, Portfolio Manager & Analyst at PRESCIENT INVESTMENT MANAGE - MENT

says ESG considerations are driven by clients’ needs and the company has specific mandates that focus on this.

“The Prescient Living Planet Fund, for example, aims to deliver sustainable long-term capital growth to investors while ensuring a level of environmental and social integrity. The Fund is managed by utilising the combined expertise and experience of Prescient Investment Management and the World Wide Fund for Nature ( WWF) – the world’s largest conservation organisation.

“The key focus of the fund is on environmental integrity and avoiding companies that fare poorly in this regard. With all of Prescient’s Funds we actively vote at shareholder meetings, where we follow internal policy guidelines as well as King III,” says

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Manjoo.

says the company applies a principles based methodology to incorporating ESG in its approach as its view is that companies managing ESG issues effectively are, overall, more likely to have sustainable business models, a competitive edge and the ability to manage long-term risk to shareholder value.

“For example, good governance practices as demonstrated through a company’s appropriately structured board of directors, along with appropriately remunerated and incentivised executives, are generally correlated to creating shareholder value over the long term. In calculating our intrinsic value of a company we incorporate the impact of factors such as changing regulation, carbon taxes and mine closure costs into our base case or as part of a ‘bull’ or ‘bear’ scenario, which we calculate for each company.

“In respect of engagement, we believe in collaboration and prefer not to take the public route. Rather, we work with the management and the board behind the scenes to drive any change. If we do not see positive change forthcoming, exiting the investment is an option.

“Our view is this approach to engagement works better and boards are more readily available to discuss issues and even sometimes seek out our advice for further insight. We are firmly of the view that engagement is an effective part of our ESG strategy,” says Linley.

Karl Leinberger, CIO at CORONATION FUND MANAGERS

says the company’s primary focus is to ensure that it manages clients’ money in accordance with the investment mandates given to it.

“We incorporate ESG factors into our investment decision-making process in a manner that is fully consistent with our long-term investment horizon. We believe companies cannot achieve sustainable economic success while neglecting their social and environmental responsibilities.

“In our view, ESG issues form an intrinsic part of the mosaic for any investment case. Poor ESG performance may not necessarily exclude investing in a company, but it does force us to carefully consider the issues and engage management on those issues. Furthermore, we feel it is very important to focus our attention and time on those ESG issues that have the most meaningful impact and where our expertise lies, rather than on issues that are intrinsically fraught with ambiguity.

“Once the valuation of a company is completed, considering ESG and other factors, the portfolio manager

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Questions for fund managers: will decide to include it (or not) based on the expected risk-adjusted returns of the particular share and its interaction with other companies in the portfolio.

“We think that engaging with the companies in which we invest is a critical part of the ESG process – this is where a large part of the ‘heavy lifting’ is done and in our experience this has been effective,” says Leinberger.

Mahesh Cooper, GRAY

director at ALLAN

says the company takes a long-term view when considering an investment, as its purpose is to help clients build long-term wealth.

“This means that sustainability is important to us in our overall investment appraisal. Our investment philosophy recognises that, in the longrun, a company cannot achieve sustained economic success while neglecting its environmental and social responsibilities. Over time, irresponsible conduct will weigh down on a company’s valuation and, consequently, its investment performance.

“Our assessment of a company’s management and its governance structure is also an essential part of the investment research process. Responsible investing considerations are therefore always taken into account during the investment process.

“Our research process is on-going – the analyst will continue to monitor all factors (including ESG considerations) that could impact the value of that business going forward (and therefore change the investment case).

“Once our clients are invested, we will support, on their behalf, anything that we think makes the business a better long-term financial prospect. This typically means that we are supportive of measures that improve sustainability, but tend to look at these through an ‘economic’ lens. We do not consider ESG issues in isolation, but rather incorporate these and many other factors in our bottom-up company analysis.

“We believe that we can assist investors to diligently exercise their ownership responsibilities by: Engaging, on their behalf, with company directors; and Recommending how they should vote their shares at shareholder meetings. “We have achieved success through our engagement with company directors and executives. By encouraging behaviour which enhances or preserves shareholder value, we hope to look after the best interests of our clients in accordance with our aim of creating wealth for our clients over the longterm,” says Cooper.

He says if efforts at constructive engagement fail, and the firm continues to harbour material concerns about the strategy, sustainability or governance of a company, it may begin to engage with the company’s directors in a more forceful manner, including recommending that its clients vote against certain resolutions at shareholder meetings.

“If our concerns regarding a company’s strategy, sustainability or governance cause us to lower our estimate of the company’s intrinsic value, we may sell the company’s shares,” says Cooper.

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

says there is no right or wrong approach when ESG.

“The engagement versus disinvestment debate is riddled with subjectivity; personal bias and a real material risk the effects of fossil fuel investments could pose to pension fund savings. For far too long institutional investors have ignored the effects of climate change and the associated

implementing ESG risks, which could erode value for investors over time.

“The decision is not clear cut and investors have to choose the best path for themselves. Disinvestment is immediate and does send a strong message, but other methods like proxy voting, active ownership and engagement also have their place.

“We employ a range of approaches across listed and unlisted issuers. Within the fixed income asset class there is no one size fits all since the range of issues are too diverse (listed versus unlisted, sector risk), these are some of the indicators, which could influence how we view the materiality of the risk. All of this is underpinned by a strong fundamental credit approach and process.

“In addition to screening for ESG issues, as a lender we value partnerships and engagement with companies on matters that could materially affect the risk profile of our loan. Engagement is effective when a company is willing to engage and they are able to demonstrate how they will address investor concerns.

“Change doesn’t happen overnight and mindsets don’t shift easily, this is done over time, but willingness from companies and determination from institutional investors will set the scene for change,” says Kalam.

Cora Fernandez, chief executive, institutional business at Sanlam Investments

says the company started by writing policies for ESG as well as conflict of interest resolution.

“We have been voting proxies on behalf of clients using our governance policy since 2006. We also have a policy for escalations, which sets out how we engage with investee companies on behalf of clients. All our engagements to date have been to do with governance matters, and they have been effective.

“We have a project underway for our analysts to incorporate environmental damage costs into company valuations. We are also able to provide “environmental footprints” of selected portfolios, and are considering how best to communicate on them with clients.

“We use corporate governance scoring systems in portfolio construction, but to a limited extent. We think that engagement is more constructive than disinvestment. South Africa probably does not have enough listed companies for a big fund manager to use disinvestment as an on-going policy,” says Fernandez.

Nick Curtin at FOORD

says consideration of non-financial factors that could impact directly on the long-term sustainability of earnings should be integral to the investment valuation process. Indeed, it is not possible to build conviction in an investment idea if any pertinent nonfinancial considerations have not been considered in the valuation process.

“We do not disaggregate this part of the process in the same way that we do not disaggregate our assessment of the quality of management. Importantly, our consideration of these issues is aimed solely at trying to derive the most accurate valuation of a business and to discern the true risk of permanent capital loss.

“Engagement with company management is crucial to our investment management process. In our experience, effectiveness has been mixed. In those instances where it is not effective, we will review our investment thesis and act accordingly. This might require a re-weighting in the portfolio to reflect an elevated risk or even a complete disposal. Either way, management’s response to our engagements will impact our assessment of their quality,” says Curtin.

Andrew Newell, head of business development at CANNON ASSET MANAGERS

says the company’s investment philosophy has always had the long-term as one of its cornerstones. While it wasn’t initially implemented to address ESG in today’s language, the tenets of investing in businesses that are positioned for sustainability, be it environmental or financial, are key.

“Any business that is managed without due consideration for its environment or the way in which it is governed, is invested in with the near-term in mind, and philosophically, we’d argue that this borders on speculative activity, not investment activity.

“We have become increasingly engaged with company management over the years, and believe that this does in fact carry weight. To date, most of the ESG ‘wins’ have been on the governance front.

“These include the way in which directors of listed firms have been involved with dealing in their own securities, the availability or clarity of company information both via SENS or just by company websites, for instance, the willingness of management teams to engage with us as shareholders acting on behalf of our clients, and the appropriateness of business arrangements with external parties.

“While a specialist boutique might have a relatively small voice towards our large-cap stocks in particular, we have made a point of voting on every resolution of every share in which we’re invested. We consider this engagement a key part of any investor’s arsenal,” says Newell.

Mark Cliff at PSG ASSET MANAGEMENT

says the company is looking to make sustainable longterm investments that will provide a reliable, expectation-meeting return. This is not achievable by investing in companies where the behaviour of the management team is likely to be socially or environmentally irresponsible.

“It is imperative that we remain properly engaged with management and understand the ESG impact of all their investment decisions, and that we vote appropriately on corporate events,” says Cliff.

Nadim Mohamed, investment analyst at First Avenue Investment Management

says as long term intrinsic value investors, the company fully appreciates the importance of including ESG into the entire investment process, which includes engagement with management.

“Our experience is that ESG factors often have a strong influence on the uncertainty rating we attach to an investment case. In a recent example, the governance of the board and management of a listed company was found to be extremely poor as they were disproportionately favouring a majority parent shareholder at the expense of minorities through internal procurement agreements,” says Mohamed.