Going offshore for ESG investing: Here’s what you need to know

JOHANNESBURG — Sustainable, or ESG, investing is becoming a more prominent form of growing your wealth in many parts of the world. While South Africa’s JSE is internationally respected as among the world’s top bourses with good liquidity, the very nature of the companies on it (especially the big presence of mining giants) means that it isn’t a great fit for ESG investing. This is according to London-based Mike Abbott who works with Sable International’s Wealth Team. In this interview, Abbott tells us more about the growing momentum behind ESG investing and why you need to look offshore to get involved. – Gareth van Zyl

On the line from London is Mike Abbott from Sable International’s Wealth Team. Mike, thanks for joining me on the podcast.

Thanks, Gareth. It’s nice to be here.

We’re going to be talking about sustainable investing, particularly in the context of offshore investing, but let’s just take a few steps back first. What is the concept of sustainable investing and what are its benefits?

If we put sustainable investing in the continuum all the way from philanthropy – where people are willing to give their money away to a good cause – all the way through to different types of ethical investing and social impact investing etc; then sustainable investing (or what we call ESG investing) is where you are filtering your investment universe to take out the stuff that you don’t like. And that varies, depending on who is making the decisions. You can then also bring in more of what you do like within an ESG framework – the acronym ESG stands for Environmental, Sustainable and Governance.

What you’re doing there is you’re applying metrics to your investment universe (global investment universe) and you are filtering out companies that have poor governance scores, companies whose business models are not sustainable and companies whose end-business model is not good for the environment. You’re basically filtering that whole investment universe and then filtering some out and choosing to allocate more of your portfolio to those that have strong positive metrics in those areas.

Many people listening to this will wonder how the stocks on the JSE stack up to this definition. Can you tell us more about that and whether they even comply, many of them?

Because South Africa (like the Australian economy) is very much a commodity-based economy, it has large holdings of mining companies in the index, meaning it would be very difficult to actually implement a sustainable or an ESG type portfolio in South Africa. This is because one of the features of ESG investing is that your ESG investment universe is smaller than your wider investment universe. By restricting the investment universe, you’re theoretically reducing diversification and, therefore, you’re making the portfolio riskier.

As a result, if you’re in a smaller investment market like South Africa (which is just 1% of the global marketplace in terms of equities) and you’re now applying these types of filters when the bulk of your economy is the mining industry you’re left with a very small investment universe that is going to have some quite unusual dynamics to it in terms of company size, company type sector etc. It probably isn’t a good investment strategy in a country like South Africa. So to my mind, people that are interested in investing in this way should definitely look to do that on a more global stage in a more globally diversified type of portfolio.

So as you’ve mentioned they’ll need to look at a more globally diversified type of portfolio. South Africans, in particular, will have to look offshore. Where do they start?

The good news is that over the last three to four years, retail investors’ access to ESG has exploded. There are a vast number of funds now that are trackers that are smart beta type funds that are even actively managed. There are also specific theme-based funds that are focusing on this area. Thus far, the leaders in ESG and the demand for ESG investment strategies are actually present among the large institutions and sovereign wealth funds around the world. So, your really big pension funds in the US, the UK and Europe. And because they’re pension funds, they have such a long investment timeline and they have to manage future liabilities far into the distance. Subsequently, they are taking very long-term views on their investment strategy and the kind of world that we’re going to be in a number of years’ time.

Therefore, they’re in the fortunate position where they can think very long-term and the moment you start to do that, ESG becomes a very real issue within your investment mix. The institutions are driving the demand for this, but at the same time that demand has created a vast array and an entire ecosystem of tools that are data metrics for companies everywhere in the world on how they perform in areas of environmental sustainability and governance. You can only drive down the cost of accessing these strategies if you have that data ecosystem and the Standard & Poors, Fitch and all the different rating agencies are all rating companies on the basis of these ESG metrics.

With that data now out there in the open and available to all fund managers, it’s easier t build low cost quantitative based trackers that are filtering the investment universe on the basis of these metrics. And most of this is available in the UK and in the European fund markets; a lot of it’s also available in the US. So you really have to be in the offshore investment universe to make use of these tools because the South African market is still one of generally mostly active managers and active long-only stock picker type managers. The South African market’s a little bit behind the curve here, but even if they wanted to, passive providers in South Africa would struggle to build ESG type tools for the South African market — it’s just too small.

Taking what you’ve said into consideration what percentage of one’s portfolio then should consist of these ESG type investments?

That’s a really good question and I think if you speak to different academics, you’ll get a different answer here. If I walk you back about five years the data suggested that an ethical investor actually suffered a cost penalty. Well, I know that they suffered a cost penalty to access these strategies because they were more expensive. The investment universe was smaller and therefore the investment outcome was bumpier and therefore riskier. So it was quite difficult to argue that a retail investor should invest with their conscience on these issues because there was clearly a performance penalty and the whole thing was costing them a lot more.

That cost penalty has now almost completely fallen away with the advent of all of these ESG based tracker type tools and the performance penalty has also fallen away, and is starting to look like a performance premium. So the data’s really shifted over the last five years and I think this is the conversation that’s happening in the investment world. This is because the institutions have driven the demand for this and are filtering everything they do on the basis of these metrics, and retail investors now need to pay heed to that process because that’s the bulk of the investment industry and that’s going to be driving the impact on share prices. Unless you start to apply ESG thinking into your portfolio mix now, you have the potential to actually suffer a performance lag. This is all on the basis of the hypothesis that in the years to come the stock market is going to punish companies that behave badly on these metrics more than they would’ve done in the past, and that’s simply because the biggest investors in the world are applying these metrics.

From Sable International’s side, how do you specifically help investors get more involved in sustainable investing?

We’re fortunate in that we build investment portfolios here in the UK using a very big opportunity set in terms of funds. So, we have access to every kind of fund we could ever need to access and at prices that are a fraction of what they would be in South Africa because this is a much bigger investment market. We have a range of portfolios that we’ve built, we have a specific ESG portfolio that we’ve built for clients that are interested in getting targeted exposure in this particular area and we have an element of ESG tilt in our core portfolios and progressively, year-on-year, we’re increasing the degree of ESG tilt in our portfolios for the simple reason that the data is year-on-year showing that this type of investment approach, this kind of tilting and filtering of your investment universe, is providing a performance kicker.

Mike, just finally for anybody who’s listening to this podcast and they want to find out more about ESG and what Sable offers, how can they get in touch with you guys?

The best thing would be to give us a call or drop us an email. The “Wealth” section on our website SableInternational.com has a lot of information about our business or they can just email us at [email protected].

Right great, Mike Abbott, thank you so much for taking the time to chat with me today.

Thanks, Gareth. I appreciate it.

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