RESPONSIBLE INVESTING BY PENSION FUNDS: THE ABC OF ESG

By Ndabe Mkhize

Chief Investment Officer, Eskom Pension and Provident Fund

The core functions of a pension fund are to provide its beneficiaries with good enough returns for them to live on – and a good enough world to retire into.

It makes little sense to simply strive to generate financial returns for pensioners, if the investments that provide those returns are reckless, bad for our planet, or perpetuate social inequality and inequity.

It is thus common sense that responsible investing – which all investing should actually be – must go far beyond simplistic bottom-line considerations. Those tasked with making such investments must dig much deeper before taking decisions that can have far-reaching ramifications both for their fund members and society at large.

In a country such as South Africa, which is infamously the most unequal on the planet, their investment choices have an amplified impact on the poorest of the poor, who do not have the means to escape their circumstances. They cannot emigrate to fairer climes, or fight pollution, for example – they are bound to their situation.

So how should pension funds invest responsibly and sustainably?

Three factors – known to the initiated as “ESG” – come into play here: they compel fund managers to look beyond the financial, and consider the environmental, social and governance aspects of investment.

And because all three are interlinked, they need to be approached holistically: corporate governance impacts on environmental responsibility and social upliftment, for instance, social upliftment incorporates both environmental and corporate responsibility, and environmental sustainability is impossible without social upliftment and good corporate behaviour.

The environmental factor speaks to safeguarding the world we live in. There is rational argument for not investing in a company that, for example, pollutes water resources and regularly flouts emissions limits.

By perpetuating environmental degradation through investing in such polluters, pension fund investment managers frankly help to rob their pensioners of their (and their children’s) futures. They thus have a long-term responsibility to ensure that the companies in which they decide to invest are ethical and minimise the environmental impact of their activities.

The social factor interrogates how a company incorporates social considerations – diversity and inclusion, human rights, social investment, consumer protection and even animal welfare – into its operating model.

A vivid example revolves around one of the principle causes of the Marikana massacre in 2012: microlending. Desperate miners had been agitating for large wage increases in a bid to escape the microlending debt spiral in which they found themselves (a problem experienced almost exclusively by our poorest compatriots, who often cannot access mainstream banking services). The resultant strike ended, as we all know, in a bloodbath.

The question, then, is whether or not a pension fund investment manager would regard investing in providers of microcredit as responsible. My response is “no”, because microlenders all too often are predatory lenders that exploit poorer people and further trap them in the cycle of poverty.

Without embracing the social aspects of investing, it will be virtually impossible to address issues such as unemployment, inequality, poverty and our country’s low economic growth rate – and we run the risk of making our society even more unequal. That’s a scenario that we can ill afford.

Governance encompasses the rights and responsibilities of a company’s management, including its Board, executive management, shareholders and other stakeholders. It involves its corporate structure and behaviour, employee relations, and also executive and employee remuneration practices.

An obvious example of where poor governance has negatively impacted pension funds and their beneficiaries is the Steinhoff saga. Once seen as a darling of the South African business community, hundreds of pension funds had total exposure of around R25-billion to Steinhoff in November 2017.

By the next month, following revelations of massive corporate malfeasance at Steinhoff, this exposure had fallen to R7-billion – a loss of R18-billion to hundreds of thousands of pensioners. The biggest loser was the Government Employees Pension Fund, which saw its stake fall from R24-billion to a low of R1.8-billion.

By August 2019 Steinhoff’s total value had plummeted by 99%, for a total loss of R250-billion to investors. The corruption perpetrated by the company is 1 000 times that of the Nkandla scandal – underlining the point that both government and the business sector, not just the former, are responsible for better and more ethical governance.

ESG is not a new concept, of course. The idea of investing for good as well as financial returns first caught on in the 1950s and 1960s; in fact, apartheid South Africa was the target in the 1970s of one of the first large-scale disinvestment campaigns along ethical lines. Disinvestment by US companies in particular had a significant impact on the impetus to abandon apartheid.

But there was also pushback against ESG. The famed economist and Nobel economics prizewinner Milton Friedman kicked against it in the 1960s and 1970s, claiming that it adversely impacted companies’ financial performance and hurt the macro economy.

Friedman’s non-interventionist stance prevailed for much of the rest of the century, but since then the concept of social capital has come to challenge corporate self-interest as a measure of a company’s value. It has since been shown over and over that ESG in fact boosts a company’s financial performance – and it is now commonly accepted that incorporating ESG into their decisions form part of investment institutions’ fiduciary duties.

This is where the power of investors lies: by preferring to invest in companies that are well run, ethical, socially responsible and sustainable, they drive corporates to build ESG principles into the way they work and what they do. The upshot, ultimately, is a better world for all of us.

But for ESG to be effectively employed in investing, a balanced approach is required; because all three elements are intertwined, too much emphasis on one can upset the others. This is where proper metrics – such as the UN’s Sustainable Development Goals (SDGs) – come into play.

There are 17 SDGs, which address fundamental issues around the environment, social issues and, of course, governance. It is impossible for a pension fund investment manager to address them all, but certainly some can be incorporated into investment decisions.

So, for instance, say a pension fund decides that the most relevant SDGs to it include eliminating poverty, achieving gender equality and promoting responsible consumption and production, then it must focus on those in the investments it makes.

And it must take a normalised view to its investment practices, banking on the long term to produce the returns that its members need to be able to live a full and comfortable life, in a world that must be more socially just and environmentally sound than it currently is.

The institutions that control the investment capital that drives economies and economic growth, such as pension funds, have it within their power to make a positive difference to us all. But it means they have to do their homework thoroughly before they commit funds – and that’s responsible investing.