Andrew Canter participated on a panel discussion at the GEPF Annual Thought Leadership Conference 2021.
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Prepared remarks by Andrew Canter
Preamble
Futuregrowth is principally a fixed interest investor – covering a range from cash and money market funds, to credit funds, bond funds, and ILB funds. These investments are nearly entirely in South Africa for South African client investors. With about R195 billion/$13 billion under management, we are South Africa's 8th largest fund manager.
Of relevance to this discussion about responsible investing, Futuregrowth has been one of South Africa's leading developmental investors since 1995 - channeling pension fund capital into national development in a sustainable way. We have a range of developmental funds – such as rural/township property, alternative energy, agriculture, and private equity. Notably, our flagship Infrastructure & Development Bond Fund with over R15 billion/$1 billion has a 25 year track record of outperforming market indices and, I would guess, just about every other bond fund in the country… while funding a range of developmental sectors such as water, roads, airports, low income housing, SMME finance, urban renewal, agribusiness and more. That performance is not magic: The fund takes credit risk, liquidity risk, and market risk - so investors should get higher returns. The fact that the sound returns have persisted for 25 years simply means we have done a decent job of managing those risks.
Developmental and Responsible
What we’ve learned is that it’s nearly impossible to be a "developmental" investor without also being a "responsible" investor. The two dovetail neatly. So we’ve come to see our role as a "responsible capital allocator" which implies that we provide capital to worthy enterprises, and deny capital to the unworthy. The mechanism for that is an integrated risk assessment coupled with risk-based-pricing. By “integrated risk assessment” I mean that we integrate financial and non-financial factors – including so-called ESG factors – into our assessments of risk. The higher the risk then the higher the cost of capital and the lower the capital available.
Change of State
The world is riven by political division, inequality, and a huge amount of worry, so it is really encouraging to see some important societal "tipping points" being reached. For example, the sudden (and surprising) upwelling of choice in terms of things like gay marriage or cannabis use – after decades of deferral – is encouraging. Notably, after more than 30 years of clear evidence of global warming, investors and citizens have finally reached a “sudden” tipping point on carbon emissions. This has happened with remarkable speed: The phrase "stranded resources" went from being a theoretical concept to a reality in about 18 months. Personally, I look forward to the "tipping point" away from the factory farming of animals and toward plant-based proteins – something which should have gotten quite a big “shove” from both the new focus on greenhouse gas emissions (e.g. cow farts) and a global pandemic that can probably be directly linked to factory farming of animals for our food chain.
Key Lever of Responsible Investing: Cost of Capital
Many think responsible investing, or ESG screening, comes down to binary decisions – invest or don’t invest. Sometimes that is true, but in general, the process is more nuanced: With integrated assessments coming to bear on risk-pricing by the market (e.g. “you emit more toxins than the other guy, so your funding rate is higher than his”). Thus, ultimately the rising focus on various ESG issues has the effect of altering the cost-of-capital for various issuers and sectors of the economy. If investors ‘hate’ coal (i.e. higher risk) then coal shares are shunted, trade on low PE ratios, can’t access capital, and become dying businesses. By contrast, new technologies – say hydrogen or batteries – can attract capital at a low cost (i.e. high, or even infinite, PE ratios) and thus gain financing for growth. The same concepts apply – in lesser scale of differences across sectors, as investors might bias toward low-carbon emitters, or high female-composed management teams, or companies with better auditors or more robust remuneration policies.
The Rise of ESG
Naturally, Futuregrowth applauds the enormous new focus on ESG and responsible investing by investors and their managers. It has been close to our heart and mission for over 25 years.
Unfortunately, there is quite a lot of what I'd call "ESG theatre" going on in the world. I’d like to offer some comments on the roots of that.
The tyranny of benchmarks
Listed equity managers - who have their investment universe defined by and measured against listed equity benchmarks - must have a really hard time being holistically responsible. For example, South Africa's JSE Top40 index includes two or three issuers which (in Futuregrowth's view) are embargoed for investment (such as MTN, Tiger Brands, Glencore) due to their bad behaviour or culture… and a few others which are strongly suspect (such as Sasol or Exxaro) due to their core business.
A good example is South Africa's most damaging corporate disaster: The fraud and failure of Steinhoff. To our eye, the problems at Steinhoff were clearly visible - in their behaviours and even in the press - from about 2010. Futuregrowth embargoed loans to Steinhoff in 2009. But could any listed-equity managers have afforded to have a 0% weight in a share which was a meaningful portion of their index and was consistently beating the market? They probably would have been fired by their clients in 2011-2012, long before the failure in 2018. Or, to put it differently, you would have appeared to be “wrong” for a decade before finally being “right” for two weeks (the crash)
Thus, the slavish devotion to indices by asset owners and fund managers is a big, systemic problem for Responsible Investment.
You might ask: How can Futuregrowth embargo such large firms? Futuregrowth is a fixed interest house, which means that we are not stuck with bond benchmarks: We have the luxury and choice to embargo borrowers such as the ones I've named. Our universe is not merely listed, but includes the depth and breadth of the economy. Our core duration benchmark is the government-bond dominated All Bond Index, and we have never accepted (nor will we) any “Credit Index” as a proxy.
As noted, our analytical tools aim to identify sustainable businesses - financially, operationally, strategically, culturally. Those tools include ESG indicators. It all comes down to a) risk assessment, b) risk-pricing, and c) embargoes where necessary.
A less concrete set of analytical tools
Investment managers are experts on financial and economic assessments. Unfortunately, ESG assessments are much less standardised or easy to build a process around, as different industries have different measures and focal points. In the ESG space – without real auditable standards – it is easier for issuers to provide investors with incomplete, sanitised, or biased information. Let’s be frank, issuers are masters at presenting sales-pitches to investors – ESG factors are merely a new, uncontrolled, form of storytelling for many.
Given that, an emerging survival strategy for asset managers is to outsource assessments to ESG Ratings Agencies - which are, in my view, about as suspect as Credit Ratings Agencies. These service providers are also subject to sales pitches and compromise. Ultimately, they are not fiduciaries and they are not responsible for investment performance. In the end, asset managers are expected to exercise judgment on behalf of funds – and the ESG tools are probably not yet up to the task of resolving the judgment challenge.
Going beyond company analysis
Futuregrowth thinks a responsible investor should engage in the architecture in which we operate, in order to protect investors and society. It remains unclear to us why the investment industry struggles to cooperate more effectively on some key issues of mutual benefit. For example, listed exchanges are not investors' friends. You merely have to look at the business case for exchanges: their "clients" and revenues come from getting new issuers… while they have a ‘systemic lock’ on the trading of listed instruments as well as regulatory regimes (e.g. Reg 28, CISCA) that require investors buy listed instruments (as if that were some imprimatur of quality or liquidity). Even if an exchange genuinely wanted to support improved listing or reporting standards, issuers will simply threaten to go to weaker exchanges. It’s a race to the bottom. And, in the result, investors’ concerns – which are rarely expressed with a uniform voice – are poo-pooed away.
To address some of these issues, Futuregrowth, along with ASISA, has been working hard to improve the listing standards for debt instruments - which are, by any standard, utterly contemptible.[1]
Another obvious area for collaboration is the protection of whistleblowers. All investors know that corporate insiders are best placed to be aware of, and ultimately report or prevent, fraud and malfeasance. South Africa has a web of overlapping legislation for whistleblowers, none of which actually works to protect or encourage whistleblower. The fact is that a whistleblower in South Africa is likely to be hunted down, demonised, ridiculed and – worse – to have the legal system weaponised against them, and ultimately they become unemployable. This situation works directly to the benefit of corporate crooks, and to the detriment of investors. To provoke the discussion, Futuregrowth and the Old Mutual Investment Group have recently funded independent research into what can be done to improve whistleblower protections, and thus serve investors and society. We will actively participate in this discussion, and seek to mobilise our compatriots in the asset management industry to do likewise.
*Panel Participants
Discussants:
- Rob Bauer, Maastricht University and Executive Director, ICPM
- Andrew Canter, Chief Investment Officer, Futuregrowth Asset Management
- Claudia Kruse, Managing Director, Responsible Investment & Governance, APG Asset Management
- Renosi Mokate, Chairperson of the Government Employees' Pension Fund (GEPF) and PRI Board Member
- Eduardo Piquero, General Director, MexiCO2: Plataforma Mexicana de Carbono
[1] Watch a recent webinar (31/8/2021) on our work to improve the JSE Debt Listings Requirements: https://www.futuregrowth.co.za/insights/investor-activism-in-action/
