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The Business Case for ESG Integration

May, 2018 - While elements of environmental, social, and governance (ESG) considerations have been present since the 1970s, their prominence in the investment process increased significantly in 2006 with the establishment of the Principles of Responsible Investment (PRI) backed by the United Nations. The PRI was developed to encourage investors to incorporate ESG factors into their decision-making processes and to promote a more sustainable global financial system.

The overarching objective of the PRI is to deepen investors' understanding of sustainability implications and encourage responsible investment practices. By integrating ESG considerations into investment decisions, investors can contribute to addressing environmental and social challenges while also seeking financial returns. The PRI has played a pivotal role in driving awareness and adoption of responsible investment practices, fostering a more holistic and sustainable approach to the global financial landscape.

The 2017 NATIXIS Global Survey revealed intriguing insights into global investors' preferences and priorities. The survey indicated that a significant proportion of investors, 67%, considered it important to invest in companies that align with their personal values. Furthermore, a substantial majority of investors emphasized the significance of investing in companies with strong environmental records (70%), companies engaged in socially beneficial activities (71%), and companies with ethical governance practices (78%).

Remarkably, 71% of respondents expressed a specific interest in making investments that contribute to advancements in healthcare and education. These findings resonate with the prevailing sentiment among South African institutional investors and organizations, which increasingly seek to address historical injustices and present inequalities by directing investments towards social good, education, and healthcare initiatives. This alignment reflects a growing recognition of the need to use investment as a tool for positive impact and the desire to contribute to societal advancement and redress imbalances.

The Big Question

The question of whether South African asset/investment managers, trustees, and asset consultants should invest in companies focused on ESG is a pertinent one. It begs consideration of whether such investments are driven solely by stakeholder pressures or if they genuinely improve returns. Two compelling sources shed light on this matter.

Firstly, a comprehensive study conducted by Deutsche Asset Management in collaboration with the University of Hamburg examined the impact of integrating ESG into the investment process on corporate financial performance (CFP). The findings of this study, which represents the most extensive review of ESG and CFP, demonstrate a strong empirical foundation for the business case of ESG investing.

The study revealed a positive correlation between ESG and financial returns across equity and non-equity asset classes, with the highest correlation observed in real estate investments. Notably, the research identified governance as having the most significant positive effect on returns. Moreover, the study highlighted the positive relationship between ESG and CFP in emerging markets, including South Africa, which exhibited a 65.4% positive relationship compared to other regions.

This aligns with survey evidence from the United Nations-supported PRI, indicating that emerging markets are more actively engaged in ESG issues than developed markets. A significant number of South African respondents strongly agreed that a company's management of ESG issues provides insight into its overall operations.

Secondly, the MSCI Emerging Markets ESG Index analysis covering a nine-year period until December 2016 revealed that emerging markets, including South Africa, derived greater benefits from ESG considerations compared to developed markets. The annualized returns of emerging markets exceeded their benchmarks by 4.23%, while developed markets achieved a marginal 0.01% above their benchmarks.

In conclusion, the recent evidence from emerging markets, including South Africa, indicates that ESG practices have evolved beyond a superficial facade and have become essential tools for sustainable and high-performing investments. ESG considerations are rapidly becoming a primary focus for investment managers responsible for overseeing portfolios.

Instead of debating the business case for ESG investing, the focus should shift towards identifying the specific components of ESG that can effectively mitigate risks and improve returns. At Summit Africa, the notion of "investing to do good" is not a fashionable cliché, but a core aspect of our investment approach, strategy, and selection criteria. We firmly believe in the power of responsible investing to drive positive change while delivering sustainable financial results.

Embracing Responsible Investing for a Sustainable South African Future

Sustainable Investing: Not a One-Size-Fits-All Strategy

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