When constructing a portfolio or simply trying to decide on what shares to buy, the main things you would likely want to know is how the company has performed in the past, how analysts view its prospects going forward, and how it fits in your current portfolio. Thereafter, you hold thumbs that historic performance repeats itself and the analysts know what they are talking about.
Something that might provide some peace of mind when constructing your investment portfolio is ensuring that the companies you invest in follow responsible ESG practices. The three pillars of responsible investing are Environmental, Social and Governance. We take a look at the importance of each pillar below and highlight a few South African companies that are leading the way - or not.
A company that is environmentally friendly will make some investors jump for their wallets, while others could not care less whether 2 billion or 3 billion litres of water goes to waste during its everyday operations. The reality is, you should care. If a company is less wasteful when it comes to water consumption, it is not only being kind to the environment but is also saving money which could be invested in other useful ventures, which in turn could improve company profits. In 2004, a new regulation was imposed on several states in the US stating that there should be a 30% decrease in carbon dioxide emissions by 2016 for all cars sold in those states. This means that if the cars a company manufactures do not meet the criteria, it will most likely lose market share in the US which spills over to reduced profits and earnings for shareholders.
Corporate governance refers to how a company’s employees and employers operate internally and how shareholders’ wealth is protected. A good corporate governance structure would imply that the company board of directors can independently make company decisions in favour of shareholders. This reduces the risk of management making company decisions that would benefit themselves but be unfavourable to shareholders. Another key part of corporate governance is an independent audit committee. This leads to higher quality, fairly presented financial reports which investors can view as reliable. An example of why this is important is evidenced by the recent Steinhoff scandal, which brought the company to its knees due to irregularities in its financial statements. This cost the company its position as the 11th largest listed company on the JSE ALSI and it will fall out of the Top40 Index with the next index rebalance in March 2018.
A company’s social responsibility refers to an ethical framework where it has an obligation to act for the benefit of society at large. This could be anything from low-interest study loans, fund raisers for charitable organisations, or setting up schools in rural areas. All these initiatives are an investment in the future of our economy by better educating our youth, promoting awareness of health and creating a safe environment to learn and live in.
One of the companies that stands out in the ESG department is Standard Bank [JSE:SBK]. In 2012, it claimed the award for the ’greenest’ SA company, according to the Newsweek Green Rankings. Standard Bank has a Corporate Social Investment (CSI) initiative where it allocates at least 1% of each year’s after-tax income to various community interventions. It is also the only South African Bank with a membership to the Business Council for Sustainable Development of South Africa (a forum for South African businesses which focuses on deteriorating environmental conditions in South Africa).
Sanlam [JSE: SLM] is another company to have a look at. It has adopted the King III Code of Governance Principles (Introduced by the Institute of Directors in Southern Africa in 2009) and has an independent director as chair of its board for both Sanlam and Sanlam Life. Sanlam also started the Blue Ladder School initiative. The initiative aims at improving math education, school facilities and nutrition to children in South Africa. So far, Sanlam has partnered with 25 schools in the country which amounts to 21 000 children.
The bottom line is, if a company you consider investing in has these factors in place, then there is little room for unwelcome surprises like new environmental laws or accounting irregularities that could harm the company and in turn the value of your investments. There is also empirical evidence to support the importance of responsible ESG practices and their impact on investment returns. Just have a look at the consistent outperformance of the MSCI Emerging Market Leaders Index compared to its parent index. The Leaders index is constructed from the parent index by excluding companies that fail to meet certain criteria based on the three pillars of responsible investing, leaving only the cream of the crop to lead the way.
As always, it is prudent to consider all aspects of a company when making investment decisions, but sound ESG practices is a characteristic worth considering in your selection process.
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Joani van Wyk
Joani van Wyk joined the asset management team in January 2017, responsible for quantitative research of equities across all industries. Joani completed her degree in Mathematical Science in 2015, as well as an Honours degree in Financial Risk Management in 2016, both at the University of Stellenbosch. She is currently a CFA candidate.