Futuregrowth : What ESG means to your investment

Environmental, social and corporate governance issues (ESG) are all factors which could have a very real impact on the health of an industry or sector and yet are so often overlooked as hard issues to focus on when doing fundamental investment analysis. At Futuregrowth asset management these tenets form the backbone of their due diligence processes understanding that material risk in these areas needs to be carefully understood and priced into the investment being considered. Candice Paine

This special podcast is brought to you by Futuregrowth Asset Management. We’re chatting to Angelique Kalam around ESG issues. Angelique, what is ESG? How would the man in the street understand what ESG is?

As an investment manager, we have to manage and look after Pension Fund money. Those are our underlying clients. We’re third party Pension Fund managers and so we have a fiduciary duty, and part of that duty is to look at investments that we manage, each company that we invest in, and consider what the risk are to managing that specific company or investing in that specific company. Since we’re primarily a fixed income house, we advance loans to companies. A company would come to us and say, “Futuregrowth, we’d like to borrow R20m” and we’d assess that company. Previously, when analysts analysed companies they’d look at it purely from a financial perspective. The acronym ESG refers to considering the environmental, social, and governance issues. For far too long, investments analysts have only had a one-sided view of analysing companies and we’ve realised now, that there’s a place for investment analysis. It says that the softer issues, such as environmental, social, and governance issues are important because there’s potential risk involved there, which we should be assessing as well.

Can you give us an example of a risk that falls into one of those categories, which may have been overlooked?

Probably about 18 to 24 months ago, we started thinking about the impact of social issues around the lending sector. We know that the industry has now been formalised. They needed to comply with the international credit regulator, etcetera. You’d expect that within that industry, that they’d become more competitive and the rates for the consumer would be much better but that’s actually not what happened. Twenty-four months ago, we took a viewpoint as a house. We debated the issue internally and we came to the view that it wasn’t positive for the consumer. We felt that there was a cycle of impoverishing people continually, and that’s a great example of how you would screen (in a business) for potential social issues. Some further social issues that you could screen on is whether a company complies with labour and minimum wage standards, etcetera. Obviously, that’s relevant to industries as well, such as the agricultural sector where that type of issue is quite rife. Some examples of governance would be independence of your non-executive board members. At a board level, you always have non-executive directors. However, are there any independents as well as separation of duties between the chairman and the CEO? Some issues that are always highlighted for us as peak governance risk, is any turnover of the independents of the board as well as the risk/audit committee. Those are red flags for us and we look at that quite critically and say, “What’s happening at that company?”

This obviously forms quite an integral part of the Futuregrowth analysis process – the ESG principles. Is this mainstream across asset management in South Africa?

I think we’re definitely moving towards it becoming mainstream in South Africa. We’ve had quite significant change in regulation in 2011, through Regulation 28 of the Pension Funds Act that stipulated that Pension Funds have to give consideration to all issues that could materially impact the fund’s or asset’s sustainability and all issues including environmental, social, and governance issues. It’s part of what Pension Funds as asset owners, should be considering and we are seeing more and more Pension Funds giving consideration to this by actually, engaging the investment managers on these issues. More recently, we’ve been seeing many more investment managers coming to the party and speaking out around these issues. I think the proof is in the pudding. For Futuregrowth and I think for the industry in South Africa, it’s a learning process. As Futuregrowth, it’s been a process of learning and implementing change around these issues. Shifting mindsets around analysing investments from purely financial, to shifting mindsets around thinking about sustainability issues doesn’t happen overnight. It’s been a slow process and we’ve definitely been trying to integrate these issues more and more and over time, I think we’d be able to say that we are doing it holistically, but it’s been a process.

Is there any benefit to the company?

To the underlying borrower…?

Yes.

Definitely. For example, on the unlisted side, we structure most of the loans ourselves. We have a big credit team that does all the structuring. The benefit of that is that we have a one-one-one relationship with the borrowing company, so when we do the screening and analysis – the due diligence on that specific company – we usually give them feedback in terms of where the potential shortfalls are in terms of E, S, and G. We’re never prescriptive in telling them, “You have to fix this”. We point it out and say, “We recommend that you seriously consider this going forward, and implement a process to improve these to bring it up in terms of best industry practice”. To the company, I think it highlights the importance where they are possibly lacking, where they can improve to make their business more sustainable.

So you’re viewed as a partnership from your side, and a learning process for both company and asset manager.

That’s correct, Candice. When we partner or advance a loan to companies, we view all relationships as partnerships. We don’t have the view that we’re just going to be advancing a loan to you and we’re going to leave you to do your own thing. It’s a partnership and we want to see that company grow, improve, flourish, and be profitable so we do see it as a partnership and we engage with the company constantly. We have that relationship where I can pick up the telephone, and speak to the CFO and ask him, “What are you doing about this? Have you considered this?” Obviously, if it’s a critical item in terms of governance, we will be a little bit more prescriptive in saying we really recommend that this needs to be addressed. It’s a key thing for us and we do write it into our loans in terms of agreement where we will say, “If anything happens to the company, which materially affects the credit quality of this that would be a problem”.

Angelique, finally, what is the relevance of ESG to fixed income?

The primary thing that we want to manage at all times is to manage risk. When we’re advancing a loan, we want to make sure, as much as possible, that we manage that risk so that it doesn’t default. Obviously, we can’t account for certain external factors. When we look at including analysing the company and doing due diligence, we look at all the economics, financials, and operational stuff etcetera. The soft issues such as sustainability issues (ESG) – there could be material risk and we need to price for that specific risk. The primary objective of including ESG in any investment process is to mitigate risk. As a house/lender, we want to mitigate risk at all costs. We can’t see into the future but we need to take into account and identify – at a company level – what the risks are to a specific company, if any. Sometimes, there isn’t an environmental risk. Sometimes, the company isn’t exposed to any environmental issues that could pose a specific risk but sometimes there could be, and so we need to at least go through a process and say, “Yes, we’ve considered these. We’ve ticked the boxes”. Not that it’s a ‘ticked box’ approach, but we’ve identified. We’ve given it thought. We’ve analysed the company and yes, there is a material risk. What are we going to do about it if there is? Therefore, we will price for that risk, accordingly.

Okay. As an investor, one of the things that you’re always looking out for is mitigating risk in your investments. Angelique Kalam, Manager of Sustainable Investment Practices at Futuregrowth Asset Management. We thank you very much for your time.

Thank you, Candice.

This special podcast was brought to you by Futuregrowth Asset Management.