Ethical returns

Responsible investment and the retail investor


Many retail investors have heard the term responsible investment (RI) – however few know exactly what it means or how to capitalise on it from a local investment perspective.

In simple terms, RI means systematically integrating a consideration of environmental, social and governance (ESG) factors into the investment and ownership decision-making processes. RI emerged as the institutional investment community’s response to the growing awareness of the long-term systemic risks posed by ESG issues. For institutional investors with a long-term investment horizon the systemic nature of these risks is real and it makes sense to address them through investment mandates.

Globally the RI movement in the institutional space is championed by the United Nations-supported Principles of Responsible Investment (PRI). There are currently some 2 000 global signatories to the PRI representing over US$80-trillion of assets under management.

Why invest responsibly?

On the one hand, RI is rooted in an understanding that how we invest today determines the quality of the future we all inherit. Simply put, if we continue to invest in unsustainable companies that erode public trust, pollute the environment and drive inequality then we should accept that this be at the detriment to our planet and social systems. On the other hand, the adoption of RI is also driven by an understanding that analysing ESG issues can, and does, drive investment performance. Research from Harvard Business School, titled ''The Impact of Corporate Sustainability on Organizational Processes and Performance'' by Robert G. Eccles, Ioannis Ioannou, and George Serafeim (2009), has shown that companies with high sustainability practices significantly outperform their counterparts over the long term, both in terms of the stock market as well as accounting performance. Companies that adopt early to the sustainability trend will enjoy stronger social licence to operate, lower staff turnover, better resource efficiency, lower cost of capital, better innovation and stronger access to market.

RI for the local investor

Taking all this into account, it is not surprising that RI now has resonance within the retail investing community, both from an ethical and an investment returns perspective. There is a growing number of retail investors, globally and locally, who are waking up to the fact that ESG issues matter.

There are three broad RI options in the listed equity environment for the domestic retail investor:

  1. Traditional fundamental equity products that have incorporated ESG issues into the investment processes.
  2. Thematic-styled fundamental equity products that aim to build portfolios of companies that generate their revenue from the products or services that are part of the sustainable economy (ie low carbon, resource efficient and socially inclusive products and services).
  3. Index or active quantitative funds that aim to systematically capitalise on ESG data.

For domestic investors, the first option above should be a minimum consideration for all investments, ie the fund should be able to show how ESG issues are considered in the investment process and how voting at annual general meetings (AGMs) and company engagement is undertaken. This option can be applied equally to local and international investment funds and should be able to be assessed through fund fact sheets.

For investors who believe in the long-term growth theme around sustainable economic growth, the second option represents a viable option. Funds in this category might be single-themed funds focused on renewable energy, sustainable mobility or water or the fund may cover a broad range of themes across the green growth space. In most cases these types of thematic funds also have specific exclusions around key issues, such as coal, tobacco, etc. Funds in this category are typically also very active with regards to voting at AGMs and company engagements. The challenge with this option is that it can be hard to apply in the local market as there aren’t many listed companies whose revenue is directly linked to core sustainability growth themes. This strategy can however be successfully applied at an emerging or developed market level and there are several investment firms that offer compelling products in this space.

The last option relies on the growing body of company-level ESG data that is available through a range of service providers. ESG data is leveraged to create ESG indices or used in innovative active quantitative strategies. From an indexation perspective, ESG index products can offer retail investors market-like returns by holding a basket of companies that are measurably better when considered on an ESG basis. Coupled with active stewardship and low costs, products of this nature can offer investors, with an interest in RI, an attractive starting point. There are several ESG index products available both locally and globally – each with their own specific nuance from a weighting and construction process.

What is not covered above are options that involve negative screening based on ethical or faith based values. Such approaches can be employed but may conflict with maximising risk-adjusted returns (which is, of course, a perfectly reasonable outcome if values alignment is the primary investment goal).

Integrating RI

Old Mutual Investment Group has made a public commitment to integrate RI practises across all of its investment strategies and also innovate with regards to ESG index products. The domestic RI index product leverages ESG rating data from Morgan Stanley Capital International (MSCI), a leading global provider of ESG research. While the index itself does not have absolute ESG screens (ie no ethical or negative screens), the index construction process is based on peer-relative ESG performance. The client outcome of this approach is that for a relatively small amount of "active risk", market-like returns can be achieved by holding a basket of companies that are measurably better when considered on an ESG basis.

Chart 1 illustrates the performance of this index in relation to the JSE Shareholder Weighted Index (SWIX). Though we cannot guarantee future outperformance, the trend shown supports the fact that the ESG-led index has paid off relative to the market index.

While the ESG Index range has initially been targeted at the institutional market – we currently have some US$840m of institutional capital across a range of global, emerging and domestic market ESG index products – we plan to launch these products for the retail market later in 2018.

To learn more about RI, ESG factors and index products, please visit and search for “ESG Index”.

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