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Blue Chip Issue 81

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Blue Chip is a quarterly journal for the financial planning industry and is the official publication of the Financial Planning Institute of Southern Africa NPC (FPI), effective from the January 2020 edition. Blue Chip publishes contributions from FPI and other leading industry figures, covering all aspects of the financial planning industry. Blue Chip takes this opportunity to wish the FPI a happy 40th anniversary. Congratulations!

RESPONSIBLE INVESTMENT

RESPONSIBLE INVESTMENT ESG investing: Taking the passive versus active debate to a new arena Investment strategies focused on environmental, social and corporate governance (ESG) metrics have risen to prominence over the past decade. Globally, investors are aligning their portfolios with their ESG beliefs. While South Africa has lagged this trend to some extent, ESG investing is taking hold as investors look to bolster their risk analysis processes and generate more sustainable returns over the long term. Unsurprisingly, this has reignited the “active versus passive” debate in the investment community, with some arguing that active fund managers are better placed to address ESG issues. Regrettably, these debates tend to miss the mark, most notably when they are focused on new, complex and nuanced ESG considerations. At the end of the day, clients need clarity, and not emotive debates, to navigate the already-complex, terminology-heavy investing world. Misinterpretations The concept of ESG investing is often misunderstood – some investors view it simply as a means to enhance returns, while others believe it is an opportunity to “do good” while sacrificing returns. On the other hand, some fund managers and their smart marketing teams see ESG investing as an opportunity to accumulate more assets by offering exciting new funds. Meanwhile, greenwashing – the practice of punting a product as environmentally conscious but in an insincere manner, often through naming conventions – continues to make headlines as fund managers seek to amass assets. And so, while the intention behind ESG investing is noble, many investment strategies are not aligned to the bigger picture. 64 www.bluechipdigital.co.za

RESPONSIBLE INVESTMENT Clients need clarity, and not emotive debates, to navigate the already-complex, terminologyheavy investing world. Active shareholders can influence company behavior through two primary mechanisms: • Exercising voting rights: Formally voicing their views by voting on behalf of clients, usually in line with a well-considered proxy voting policy. By voting in favour of or against ESG-sensitive topics, one is automatically an active shareholder. • Company engagement: Actively engaging companies, either individually or as a collective, on ESG best practices, thereby influencing management behaviour. What is often cause for confusion is that there is no link between being an active shareholder and an active or passive investor. Importantly, both passive and active investors can be active shareholders. Ironically, passive investors are often unable to divest of a specific company from a portfolio, meaning they are further incentivised to take on the role of the active shareholder to influence positive change. This incentive to take action has played out across the globe, with large passive investment houses such as BlackRock taking the lead on active shareholder endeavours. Incorporating ESG There are a range of approaches to ESG investing, from “benchmark cognisant” ESG tilts to impact investing in private markets. In our view, these are the most prominent approaches in the listed equities space: • Screening: Avoiding certain companies based on undesirable ESG characteristics. Typical examples include screening for thermal coal use, or companies that focus on the production of alcohol, tobacco or weapons. • Integration: Scoring or ranking companies based on their ESG metrics, and then allocating the largest weightings to the best performers in this space. • Thematic: Investing in companies that are well placed to benefit from the long-term structural shift towards ESG (a portfolio of green energy stocks, for instance). In our assessments of ESG investing, we have drawn a distinction between the engaged, active shareholder and the construction of ESG-aligned products. The engaged and active shareholder As a starting point, one needs to consider the difference between an investor and a shareholder. We believe that as stewards of clients’ capital, irrespective of whether a strategy is rules-based (passive) or focused on stock selection (active), one needs to integrate ESG into the entire investment process. To do so, an asset manager must be an engaged and active shareholder of all assets within a portfolio, or all of the companies within a fund. These approaches can be implemented on their own or in combination. Further, the incorporation of ESG factors can be implemented actively (via stock selection) or passively (rules-based investing). While the two strategies may have similar objectives, they may end up with very different portfolios, regardless of whether they are constructed actively or passively. This once again highlights the importance of researching and understanding the portfolio and investment approach. As they say, “It does what is says on the tin.” At CoreShares, we advocate for a low-cost, efficient and transparent approach to ESG investing, underpinned by index tracking and data. But we are cognisant of the need to be active stewards on behalf of our clients to ensure that the companies we invest in are playing their part. Chris Rule, CFA, CAIA, Head of Head of Products and Client Soloutions at CoreShares www.bluechipdigital.co.za 65

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