By: Old Mutual Investment Group
Research published in 2017 by Bank of America Merrill Lynch found that US firms which ranked in the top fifth percentile of Environmental, Social and Governance (ESG) ratings between 2005 and 2010, experienced the lowest levels of volatility in earnings per share in the five-year period which followed. By contrast, companies which ranked the worst in terms of their ESG ratings experienced the highest levels of volatility.
In line with these findings, the analysis of ESG characteristics to anticipate future volatility is gaining traction in South Africa, in particular among passive investors who are mandatory holders of the index. This is according to Frank Sibiya, Fund Manager of Old Mutual Core Balanced Fund, a Regulation 28 compliant multi-asset passive fund, who says that when it comes to responsible investment, there is no need for index or passive fund managers to sit on their hands.
“Responsible investment is an active decision that can be made by indexation managers. Moreover, by integrating the principles of responsible investing into a fund’s investment process, passive managers can improve long-term performance and smooth out unnecessary market volatility while keeping fees low,” he explains.
“Recent corporate scandals and over concentration of the market, is driving the increasing necessity for passive asset managers to actively drive good governance across the companies in which they invest. In fact, as mandatory holders of certain companies, indexation managers should be even more motivated to ensure that their holdings adhere to the principles of responsible investing by actively driving the agenda,” says Sibiya.
Sibiya’s fund uses the MSCI All Country World ESG Index for tracking the Global and Emerging Markets components, to ensure that investors get exposure to companies with a strong sustainability profile and reasonably low tracking error relative to the underlying equity market.
He adds that the ESG risk in the local equity block of the Fund is managed directly by Old Mutual Investment Group’s Responsible Investment team.
Jon Duncan, Head of Responsible Investment at Old Mutual Investment Group, drives the ESG agenda with listed companies on behalf of the asset manager’s funds. “Being the largest passive manager in South Africa, Old Mutual Investment Group takes responsible investing very seriously,” says Duncan, who explains that active engagement and proxy voting are powerful tools that can be used to steer companies in a particular index towards higher ESG standards.
“Investors in an index are inherently true long-term investors, and as a consequence of that, it is in the interest of the fund manager to lower risk where possible through corporate engagement. As such, Old Mutual Investment Group continuously engages in active proxy voting to influence the business practices of companies within a tracker portfolio.”
What this comes down to, explains Duncan, is the idea of not being an absentee landlord. “We believe that better managed companies produce better long-term returns. So, for example, if remuneration practices at a particular company in the index appear to be misaligned with the corporate strategy, proxy voting and engagement allows an investor to send a very clear message to the company that those standards present long-term risk that needs to be addressed.”
Duncan goes on to say that, thanks to the sheer scale of Old Mutual, the cost of active responsible investment through proxy voting and corporate engagement is not felt by investors. “Due to our size, and because all of our proxy voting across the group is rolled up in to one team, when we go and speak to company management, we’re not just going with the share capital of one fund, but rather with the rolled up equity positions across all of Old Mutual’s client holdings.
“If an asset manager, is not taking responsible investing seriously by way of active engagement and proxy voting, they’re leaving value on the table and are failing to act in the best interest of their clients,” says Duncan.
Sibiya concludes that while, when the Core Balanced Fund was created, it was not intended to be an ESG-focused fund, it does appear to be moving in that direction. “There is an ever-growing body of evidence that suggests ESG-compliant companies perform better over the long term, and we have already seen the value derived from tracking the MSCI World ESG Index for the offshore equity component of the fund.”