Towers Watson Asset Manager Review

Peter Linley, head of Old Mutual Equities at OLD MUTUAL INVESTMENT GROUP

says yes, public pressure and regulatory changes are, and will always be, drivers of change in the investment landscape.

“Given the growing importance of environmental social and governance issues, we believe that keeping a close eye on these emerging changes is equally important as some of them may well result in structural shifts in the long term.

“An example of this is the rising public pressure and emerging regulatory response to climate change which seeks to price carbon emission as a basis for decarbonising economic growth. Winners in this scenario could either be businesses that are able to decarbonise their revenue growth faster than their peers or businesses that provide goods or services that address climate challenges.

“In the context of South Africa this has relevance for the platinum sector where a ‘bear’ case could arise from reduction in catalytic converter use due to increased auto recycling requirements and increased electric car production. Alternatively there is the potential for a ‘bull’ case associated with the growth of the hydrogen economy and the use of fuel cells,” says Linley.

Fazila Manjoo, Portfolio Manager & Analyst at PRESCIENT INVESTMENT MANAGEMENT

says ideas and attitudes concerning investing are evolving and it is no longer just about financial returns. There is increasing evidence that good social-ethical performance leads to sustainable economic growth, and therefore, value creation.

“Due to the large size of retirement funds, the ethical decisions of trustees can have a material impact on industries and society. Potential businesses to focus on in South Africa would be those in coal, general mining and chemicals that profit from fossil fuel production and extraction.

“There could be pressure on gold miners too, which cause serious water pollution - specifically acid mine drainage as a result of mining in the Witwatersrand basin. There are other social considerations that cover issues ranging from illegal species trades, weapons and armaments to tobacco. However, these though important, may be impacted less due to the varying values and social convictions of the public,” says Manjoo.

Karl Leinberger, CIO at CORONATION FUND MANAGERS

says regulatory pressures are increasing around the world for most industries. This is as much the case in industries that have always been heavily regulated ( for example banking and telecommunications) as those that have historically experienced less government regulation.

“Recognising the risks and opportunities presented by regulation are an important part of our research process. There are many scenarios in which regulatory changes would fundamentally change the prospects for certain stocks,” says Leinberger.

Rhynhardt Roodt, portfolio manager at INVESTEC ASSET MANAGEMENT

says there is certainly such potential. However, for real influence, it is the actual asset owners who need to exercise their power and responsibilities as the allocators and owners of capital.

“While South African legislation does present to pension funds the responsibility to consider ESG, without meaningful engagement accompanied by a clear agenda, and instruction to asset managers, this potential may not be realised.

“Understanding and engagement may be limited – barring proxy voting instructions in a handful of investment mandates – but there are a few asset owners who have rallied around specific issues. University pension funds are usually the leaders in this respect, with agendas influenced by internal staff and academics as well as the activities of other universities.

“Currently fossil fuel management is at the top of the agenda for most of these funds. While many international universities have initiated fossil fuel divestment campaigns, funds in South Africa recognise that locally the landscape is complex with many overlapping stakeholders. As such, something like the Montreal Pledge launched at the UN Principles for Responsible Investment conference in 2014, where signatories agree to report on their funds’ carbon footprint, is a more likely point of departure.

“Presently some South African asset managers are prepared to meet the demands of such a requirement on behalf of asset owners,” says Roodt.

Mark Cliff at PSG ASSET MANAGEMENT

says in as far as one can avoid exposure to undesirable investments, yes. If you are a large enough shareholder to influence management behaviour, this responsibility must be embraced. If not, and management behaviour is likely to compromise the pension fund’s ESG principles, do not invest.

Matt Brenzel Cadiz

says it is rare for increased regulatory and public pressure to enhance the investment case of a company. By its very nature, pressure will constrain either corporate behaviour or profitability, but most likely both. Look no further than the impact on the local mining industry by the assumption of all the country’s mineral rights and the imposition of BEE codes by the state a few years ago.

“In an industry absent of pricing power, margins and returns will be compromised by institutional pressure, as will share prices.

“The ability to overcome this pressure will determine the investment merit of a company. Some – like our local miners – have little or no room to manoeuvre and become greater price takers. Others have some latitude and try to diversify away from the problem area.

“The tobacco industry has been a perennial target in the sights of regulators, tax authorities and activist groups. The combined effect of ever-rising excise duties, negative press, litigation and packaging constraints have led producers such as British American Tobacco (BAT) to move into the manufacture of vapour sticks.

“It’s debatable whether this means that BAT is a more environmentally friendly company. The point is though that pressure can lead to change,” says Brenzel.

Nadim Mohamed, investment analyst at First Avenue Investment Management

says pressure and activism from mutual funds, asset managers and large investors are most effective when there is support from a sizable cohort of investors.

“We view the future ‘game-changer’ potential of this action to be highly dependent on the level of collaboration across the investor community to influence ESG related issues. In addition, we notice that the issue of pollution specifically is receiving more attention than in the past.

“For example, Beijing recently awarded its highest ever fine for pollution of US$629,000 to McDonald’s China after its waste water was found to have impurity levels well above legal limits. This again indicates the importance of integrating ESG into the investment process,” says Mohamed.

Cora Fernandez, chief executive, institutional business at Sanlam Investments

says yes, the company has seen that in the tobacco industry. Safety is a major issue in car and mining production. Public interest in wellness is showing up in the food and beverage industry.

“Interestingly, in our 2015 Sanlam Benchmark Survey, 64 percent of standalone retirement funds thought the regulator should put pressure on asset managers to invest responsibly.

“Regulation will affect industries directly and through pricing signals imposed by taxes. Industries and companies are subject to on-going ‘creative destruction’ as consumers re-allocate their incomes, and the pace of change is subject to ‘tipping points’,” says Fernandez.

Nick

at

says understanding the long-term social, economic and geopolitical themes and direction of travel is crucial when building diversified long-term portfolios.

“By way of example, we are currently seeing a notable socio-political up-well in response to the growing inequality divide globally. Combined with increasingly strained public finances in most parts of the world, the likely political response in the form of higher taxes on wealth will have material impacts on many industries and companies.

“Similarly, the regulatory pushback against multi-nationals shifting profits to friendlier tax jurisdictions will have to be factored in when forecasting long-term sustainable earnings.

“In the South African context, the introduction of a carbon price will also have obvious ramifications for a number of industries and large companies. Importantly, these changes will also lead to opportunities.

“Staying ahead of these secular trends and positioning accordingly is an essential

Curtin

at FOORD

part of the active investment management process,” says Curtin.

Mahesh Cooper, GRAY

director at ALLAN

says all of the company’s fundamental research reports include a section on relevant ESG matters, because it believes that irresponsible conduct, polluting activities, negative health and environmental impacts, unusually high returns on capital, lacking accountability to shareholders and an imbalance in the competing demands made on a company by its shareholders, employees, customers, suppliers, government, society at large and local communities (to name but a few) may attract regulatory scrutiny and/or elicit a public response.

Such responses may affect a company’s ability to operate sustainably and therefore adversely influence the investment case.

“Of course, our view on some of these factors may differ from the views of other investors – that is what makes a market. Just as there is scope for different views on the sustainability of a company’s competitive advantage, there is scope for investors to have different views on ESG matters.

“We believe that by performing rigorous, fact-based research on ESG matters we may, from time to time, form a divergent view from the consensus that may alert us to the opportunity to buy a share at a discount to its intrinsic value.”

Cooper says examples of present South African regulatory risks are numerous, including: New legislation that may ban smoking in casinos, which could lead to declining industry revenue; Environmental legislation (such as minimum emissions standards and carbon taxes) affecting the major greenhouse gas emitters, such as Sasol; and Stricter BEE legislation hindering the expansion of some businesses and diverting the focus of management teams on operational issues.

Mohamed Mayet, MD of SENTIO CAPITAL

says ESG is often discussed as an imperative in industry forums but real regulatory pressure will only come from public pressure and that comes from awareness of the long-term negative impacts to society and the economy.

“For example, the unrest in the mining sector is partly a consequence of not enough attention being paid by companies and investors to ESG (especially social issues) and we need to address the social contract in the economy by starting to influence it from shareholder and board level.

“However, this will only came to the fore when ‘on the ground’ current economic issues become apparent to society and then to government. To us the shortterm requirement of job creation will take front seat unless ESG factors can be shown to contribute to social unrest, such as in the Marikana event.

“Nevertheless, industries such as mining and heavy industry will definitely come into the spot light sooner rather than later, due mainly to their social impact. The game changer scenario, therefore, will likely be driven by social cohesion and not just environmental or business governance issues,” says Mayet.

Andrew Newell, head of business development at CANNON ASSET MANAGERS

says the company has seen some change in behaviour, to the extent that management of companies is aware of the needs of these social practices, and also of investment management firms’ desire to push them to address these issues.

“To this end, company management seems increasingly willing to engage with shareholders on issues that previously might have been described as ‘soft’ or ‘nice to have’. Coupled with the investment imperative, firms will find a way to navigate the changing demands in order to generate a return on investor capital that is acceptable.

“In short, companies will possibly need to explore new ideas and technologies, so that they are not avoided by investors on the grounds that they fail a number of ESG considerations. It follows, then, that the investment case for certain industries will be impacted by regulatory and public pressure. The question is: how will they adapt to these demands,” says Newell?