Let’s Talk Sustainable Investing

What is Sustainable Investing?

Merriam-Webster defines investing as “committing money in order to earn a financial return”. This suggests a relatively simple decision-making process based on whether the expected returns adequately compensate the investor for the anticipated risk.

While time, or the anticipated holding period of a particular investment, has always been an implicit consideration, the concept of sustainable investing has elevated its importance. Sustainable investing increases the emphasis on environmental, social and governance (ESG) principles to improve long-term investment outcomes.

Overview of ESG

Environmental and social considerations, in particular, may take many years to have a positive impact on investment performance. In the short, to medium-term the profitability of companies may be negatively affected due to the increased capital expenditure and rising costs. Eskom, for example, has estimated that it will cost more than R 300 billion to upgrade its power plants to meet existing pollution standards (Businesstech, 9 March 2021).

This does not suggest that ESG factors should be ignored, as failure in any of these areas can have disastrous consequences for investors. Kofi Annan, a former UN General Secretary, stated that “good governance is perhaps the single most important factor in eradicating poverty and promoting development”. Annan was referring to governance in the public sector, and South Africa is living proof of the accuracy of this assessment, but investors have also experienced the impact of poor corporate governance in the private sector with the implosion of Steinhoff and EOH in 2017, and Tongaat-Hulett in 2019.

Environmental Criteria

The environmental criteria specify that a company should have policies on climate impact, energy usage, waste management, pollution control, conservation of natural resources and treatment of animals. Long-term sustainability of the environment is undeniably extremely important, but there is potential for organisations to be faced with conflicting priorities. The Financial Mail (July 28 – August 5, 2022) reported that the Democratic Republic of Congo (DRC) is currently auctioning parts of its rainforest in search of oil. The land for auction includes a part of the Virunga National Park, which is a gorilla sanctuary. The DRC’s representative on climate issues says the country needs to finance poverty alleviation, so their priority “… is not to save the planet”.

The DRC has exceptional natural resources, including cobalt and copper, but the majority of the population has not benefitted from their wealth, with 73% living on less than $1.90 per day.

Social Criteria

The social component of ESG requires the allocation of capital to local communities to alleviate poverty, so while the DRC decision may be criticised, it may not be totally unreasonable for them to prioritise the social component of ESG as long as they still act within the framework of good governance.

The dilemma faced by the government of the DRC is possibly indicative of the potential trade-offs that corporates will also need to make. Activities such as reducing carbon emissions, investing in renewable energy projects, or sharing profits with local communities will have cash flow implications so businesses may not be able to address them all at the same time. At the risk of being contrarian, reducing unemployment and giving people hope for a brighter future may seem like an attractive option because the benefits will accrue over a shorter time period and the results will be more visible.

In addition, from an investment perspective, there are sound reasons for investing in companies that do not currently meet the environmental criteria. Dirty energy sources such as natural gas, oil and coal are harmful to the environment, but according to the Environmental and Energy Study Institute, these fossil fuels still account for approximately 80% of the world’s energy. While companies in this sector may not be attractive from an environmental perspective, the lack of investment in dirty energy has resulted in material shortages and rising prices.

At the time of writing the share price of coal company Thungela had risen over 1,000% since it was unbundled from Anglo American and while the share price performance of other companies over the last two years may seem comparatively pedestrian, they were still notable e.g. Exxaro (+ 55%), Sasol (+ 138%), Shell (+ 87%) and Exxon Mobil (+ 113%).

The word currently is emphasised in the previous paragraph because these companies are also addressing investors’ sustainability concerns. Sasol and Exxaro are both striving to be carbon neutral by 2050, Shell is investing in renewable energy sources like solar, wind, hydrogen, tidal and geothermal power, and Exxon Mobil is investing in biofuels. The increased cash generation resulting from high commodity prices will surely accelerate investments into these projects, even despite the imposition of the Energy Profits Levy in the UK.

Governance Criteria

The governance criteria that are measured in ESG investing require that companies use accurate and transparent accounting methods, they act with integrity and diversity in the appointment of their leadership, and they are accountable to their shareholders.

Financial statements are based on historical information and are independently audited so theoretically they will provide a relatively accurate picture of past events.

However, an analysis of good corporate governance should preferably provide some insights into the ethics and values of leadership against which they can be evaluated at a future date. In their 2016 Annual Report, EOH stated that its purpose was “To be an ethical and relevant force for good and to play a positive role in society, beyond normal business practice”. They also stated that “Corporate governance is integral to EOH’s business philosophy of ethical leadership”. These are good measures against which to evaluate the performance of EOH’s leadership and their commitment to good governance.

Given what has subsequently transpired questions could be raised as to the validity of these statements during the tenure of the management team at that time. Still, it does suggest that perhaps greater emphasis should be placed on quantitative criteria that can be measured on at least an annual basis to provide investors with more compelling evidence of exemplary corporate governance.

The key takeaway

While there is a possibility that sustainable investing may delay the financial return on investors’ “committed money”, there is no doubt that fewer carbon emissions, lower unemployment rates and improved governance in the private and public sectors will ultimately benefit us all.

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