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. Weâre 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. Weâre 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 weâre primarily a fixed income house, we advance loans to companies. A company would come to us and say, âFuturegrowth, weâd like to borrow R20mâ and weâd assess that company. Previously, when analysts analysed companies theyâd 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 weâve realised now, that thereâs a place for investment analysis. It says that the softer issues, such as environmental, social, and governance issues are important because thereâs 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. Youâd expect that within that industry, that theyâd become more competitive and the rates for the consumer would be much better but thatâs 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 wasnât positive for the consumer. We felt that there was a cycle of impoverishing people continually, and thatâs 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, thatâs 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, âWhatâs happening at that company?â
This obviously forms quite an integral part of the Futuregrowth analysis process â the ESG principles. Is this mainstream across asset management in South Africa?
I think weâre definitely moving towards it becoming mainstream in South Africa. Weâve 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 fundâs or assetâs sustainability and all issues including environmental, social, and governance issues. Itâs 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, weâve 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, itâs a learning process. As Futuregrowth, itâs 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 doesnât happen overnight. Itâs been a slow process and weâve definitely been trying to integrate these issues more and more and over time, I think weâd be able to say that we are doing it holistically, but itâs 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 â the due diligence on that specific company â we usually give them feedback in terms of where the potential shortfalls are in terms of E, S, and G. Weâre never prescriptive in telling them, âYou have to fix thisâ. We point it out and say, âWe recommend that you seriously consider this going forward, and implement a process to improve these to bring it up in terms of best industry practiceâ. 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 youâre viewed as a partnership from your side, and a learning process for both company and asset manager.
Thatâs correct, Candice. When we partner or advance a loan to companies, we view all relationships as partnerships. We donât have the view that weâre just going to be advancing a loan to you and weâre going to leave you to do your own thing. Itâs 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, âWhat are you doing about this? Have you considered this?â Obviously, if itâs 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. Itâs a key thing for us and we do write it into our loans in terms of agreement where we will say, âIf anything happens to the company, which materially affects the credit quality of this that would be a problemâ.
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 weâre advancing a loan, we want to make sure, as much as possible, that we manage that risk so that it doesnât default. Obviously, we canât 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) â 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 canât see into the future but we need to take into account and identify â at a company level â what the risks are to a specific company, if any. Sometimes, there isnât an environmental risk. Sometimes, the company isnât 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, âYes, weâve considered these. Weâve ticked the boxesâ. Not that itâs a âticked boxâ approach, but weâve identified. Weâve given it thought. Weâve 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 youâre 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.