The ESG differentiator
The year 2020 has made an indelible imprint on this generation, as the world grappled with a global health crisis not seen since the outbreak of Spanish flu in 1918. Coronavirus updates almost, but not quite, bleached out news of the US crisis of democracy, negative oil prices, widespread social unrest, the conclusion of Brexit, a Siberian heat wave, South Africa falling out of the investment-grade universe, Louis Vuitton making hand sanitiser, and even the death of Darth Vader.
What was notable was the resilience in stock markets following the March 2020 crash, even if real growth was narrowly driven by tech and precious metals counters. The pandemic accelerated trends in investor preferences, with flows into ESG (environmental, social, and governance) funds standing out. Prior hesitancy gave way to a heightened awareness that normalised incorporating ESG factors into investment processes.
Funds that include some kind ESG component climbed to more than 20% of total assets under management (AUM) in the US, and to nearly 50% of AUM in Europe, officially taking ESG investing into the mainstream. In March of 2020, BlackRock announced broad plans to address climate change, including divesting from companies that generate more than 25% of their revenues from thermal coal. This was rewarded by their iShares ESG ETFs taking nearly 40% of total net iShares inflows in the first half of 2020, versus just 7% the previous year.
As shown in Figure 1, this trend is echoed by the acceleration of flows since 2019 into ESG “smart beta” funds, or ETFs that incorporate ESG factors as part of their systematic selection of stocks from a particular index.
Figure 1: Net flows into US ESG Equity Smart Beta funds
Norway’s Sovereign Wealth Fund followed through on its commitment to exclude some major coal commodity companies from its portfolio. Oil giant BP set a net zero target by 2050, shortly followed by Royal Dutch Shell, while JPMorgan Chase and Goldman Sachs set fossil fuel lending restrictions and, for the first time, refused to fund Arctic exploration. Arguably, the most notable example of going green is China’s commitment to a Net Zero Emissions agenda by 2060, with Japan and South Korea quickly following suit, with widespread implications for multiple sectors.
The year closed off with a record number of resolutions being passed at companies’ annual general meetings (AGMs) globally, which addressed issues from climate change to employee diversity. Meanwhile, ESG mutual funds saw net new money growth of c.20% versus active equities showing a net 3% to 4% redemption rate (Morgan Stanley Research, October 2020). This highlights the market share shift in favour of players with strong ESG credentials.
Locally, ESG concerns focused on inequality and climate change. Executive and non-executive pay received attention, building on the surge of corporate engagements and shareholder protests over remuneration that marked 2019 (Sasol, Rebosis, Woolworths, Shoprite, Bidcorp). There were also waves of company retrenchments (Telkom, Edcon, Bidvest, Massmart). SA banks focused on climate change disclosure and fossil fuel financing, with Nedbank breaking away to become the first company in South Africa to table climate financing resolutions voluntarily. And then, of course, there was Sasol.
ESG integration at Matrix Fund Managers
Investment company statements demonstrated that 2020 was also a watershed year for the incorporation of sustainable investing considerations into investment processes. Likewise, Matrix Fund Managers is proud to announce full integration of a comprehensively enhanced ESG strategy and practice across our equity investment process, having invested in the necessary team capacity to drive and maintain that change.
This contributes to the fulfilment of our objective to ensure sustainable returns, to protect value for our clients, and, as part of our fiduciary mandate, fulfil the ownership rights and obligations of our clients on their behalf. The conscientious and consistent exercising of voting rights, active corporate engagement, and the integration of sound ESG considerations into our investment process are the three pillars by which we uphold this responsibility.
Our process is supportive of our existing investing process and is a value-differentiator. ESG factors are increasingly being priced and rewarded (or punished) by the market, although they are rarely incorporated into company valuations by the South African long-only asset-management community. We implement our ESG process in a resource efficient manner, by focusing only on the issues that are material to the holding’s investment case.
We incorporate our ESG process across all the phases of our investment cycle. At the screening phase, where a review of any ESG issues is flagged as being material, we assess management’s response to these issues and incorporate a proprietary ESG score into an overall quality score for the company. At the valuation phase, ESG considerations inform valuation drivers and discount adjustments. At the post-valuation phase, we analyse the impact of various ESG scenarios on our valuation estimates. Finally, during portfolio construction and implementation phase, we rigorously debate position sizing in relation to the ESG concerns.
In actively fulfilling our role of stewardship, we aim to mitigate identified ESG risks via close monitoring for signals of change, active voting of our proxies, and engagement with companies’ management on the key issues of concern. It is on this multi-tiered foundation of integrating ESG aspects into our investment process that we are proud to indicate that we have the capacity, inclination, and credentials to create bespoke and specific ESG products. We believe that expertise and a thorough understanding of how material ESG concerns are addressed at a company level – via active investment case interrogation and company engagement – are what will ultimately separate real mispriced opportunities from greenwashed ratings chasing.