Wednesday, May 22, 2019 UTC

AGF Magazine - May 2019 issue

  • Analysis: The Cookie-Cutter Conundrum: Deploying Dry Powder in SSA
  • Analysis: How the evolution of the African model for PE sector continues to attract innovative solutions?
  • Comment: How International Financial Centres Can Fuel African Economic Development
  • News: Launch of the first impact investing platform in Mauritius
  • Subscribe Today! Visit Magazine page
Analysis > Analysis and Strategy

South African hedge funds: Not ready for ESG?

Anna Lyudvig
Oct. 25, 2015, midnight
631

Word count: 1565

South Africa formally encourages investors to integrate into their investment decisions sustainability issues such as environmental, social and governance (ESG). Anna Lyudvig explores whether SA hedge funds have been taking ESG issues seriously.

Receive ONE magazine and TWO locked articles of your choice for FREE when you register an account
Share:

South Africa formally encourages investors to integrate into their investment decisions sustainability issues such as environmental, social and governance (ESG). Anna Lyudvig explores whether SA hedge funds have been taking ESG issues seriously.

Developments in South Africa, such as changes to Regulation 28 of the South African Pension Fund Act and the launch of the Code for Responsible Investing in South Africa (CRISA) a few years ago, have put a growing emphasis on ESG (Environmental, Social and Governance) factors. South Africa mandates that institutional investors including pension funds “give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund's assets, including factors of an environmental, social and governance character”.

Pension funds are one of the primary investors in South African hedge funds. While it seems that SouthAfrican government is serious about sustainable investments, has the South African hedge fund industrybeen proactive with ESG implementation? James Brice, Managing Director at EBS Advisory, thinks that ithasn’t, saying that hedge funds have been “very slow to incorporate ESG into the decision-making frameworks”.

“In fact, since the key personnel have left GEPF [Government Employees Pension Fund] and PIC [Public Investment Corporation], the whole CRISA momentum has really been lost. At best, small investment firms have generated a policy and placed it on the website with no further action, but the majority have not done even this,” he stresses.

Eugene Visage, Head of Hedge Fund Investments at Novare Investments, agrees, saying: “There has been increased awareness by investors towards this type of investments approach, but SA (and more specifically the local asset managers) are still lagging when compared to its international peers.”

Even though some SA hedge fund managers have started incorporating some of the ESG principals in their investments analysis, it is still in its infancy - Eugene Visage“Even though some SA hedge fund managers have started incorporating some of the ESG principals in their investments analysis it is still in its infancy,” he adds.

For Claire Rentzke, Head of Manager Research at 27four Investment Managers, South African hedge fund industry has been “mostly reactive” with ESG implementation: “Probably there are a large number of industry participants who may say that they do integrate ESG factors into their analysis but that it is at a very superficial level.”

Rentzke says that ESG integration is one aspect of a manager’s policy regarding responsible investing and SA hedge funds in some instances do pay attention to some of these factors in their analysis process.

She points out that hedge funds in SA are predominantly long/short equity and the managers won’t disclose their short positions for fear of not ever being given an audience with management: “This curtails the extent to which they can then implement other aspects of responsible investing especiallyaround engagement with companies.”

"Also those hedge funds that have trading books are not interested in being long term, patient investors and for them the investment case is all about exploiting a short term anomaly in the share price rather than investing long term, engaging with management and having a view on responsible investment,” she adds.

Nevertheless, EBS Advisory’s Brice argues that ESG factors can be part of strategies that include short sales of securities, saying that management feedback on topical issues should be incorporated into asset management strategies, rather than relying on published data.

“Shorting a stock is, in our opinion, legitimate if one feels that management's response to a critical issue that resulted in the share price decline is inadequate. Similarly, buying at the bottom of the cycle of a stock that has been hit by ESG issues, such as Lonmin, is legitimate if we feel that management's responses are credible and are targeting the correct route causes,” he says.

ESG factors and investment performance

Some argue that ESG factors, when integrated into investment analysis and decision making, may offer investors potential long-term performance advantages. The link between ESG factors and investment performance was formalized by the United Nations in 2006 when it promoted the Principles for Responsible Investment (PRI), a set of practice standards offered for voluntary adoption by investors.

The PRI Initiative has quickly become the leading global network for investors to publicly demonstratetheir commitment to responsible investment, and the number of PRI signatories exposed to hedge fund strategies is growing significantly each year.

Governance factors have been shown to have the biggest impact and there is evidence that suggests that poorly run companies have poorer share price performance than well governed companies - Claire RentzkeFor Rentzke, ESG factors can affect the performance of an investment portfolio, although she says the evidence is a bit tricky and the time horizon a bit too short to be able to prove direct correlations: “Governance factors have been shown to have the biggest impact and there is evidence that suggests that poorly run companies have poorer share price performance than well governed companies. When it comes to E and S then typically a major negative event will trigger a selloff in the share price.”

As a fund of funds, 27four Investment Managers, a PRI signatory, applies its responsible investment polices at the level of manager selection. “We analyze the systems and processes that our underlying managers have in place with regards to the integration of ESG factors into their investment research and portfolio construction,” says Rentzke.

She says that 27four assesses the ability of each asset manager that they use to integrate ESG factorsinto the investment process and the importance that sustainable investing plays within the organization: “27four recognizes the importance of long term sustainable returns and as such part of our asset manager due diligence process is centered on the asset managers’ commitment to responsible investing and ability to implement ESG analysis into their process.”

Questionnaires centered on responsible investing are sent to the asset managers on a bi-annual basis.Not only is their expertise in this area assessed but also the developments and progress that they have made in the responsible investing space over the preceding six months,” she adds.

“We scrutinize the investment analysis process and the portfolio construction process to understand how the asset managers are building in an analysis of the various ESG factors and the impact this has on valuations and the ultimate portfolios. In this way we can see whether the skills exist in the investment team to properly analyze the factors and their impacts and understand if the manager is able to provide any specific ESG focus in the portfolio should clients have specific requirements in terms of their own responsible investing policies,” she says.

Stephen Brierley, Head of Hedge Funds at Old Mutual Multi Managers (OMMM), one of the PRI signatories, says: “OMMM hedge funds does place an emphasis on ESG principles both through our qualitative investment due diligence of managers and further through our corporate governance risk review. The former is performed by our investment team, the latter by a third party. If these principles are lacking in a manager we may not invest with them.”

He adds that businesses that have poor ESG principles and practices may not receive capital investmentby shareholders, particularly those investors that have a focus on ESG practices: “This would affect business share price and performance. Certain ESG regulations which are avoided by businesses may affect them in the long run in the form of fines and loss of revenue i.e carbon tax emissions.”

Brierley says that Governance is the principle which will have the greatest effect on valuation: “Managers will also evaluate the impact that businesses have on the environment and society although it is difficult to include these in valuations. Managers are not likely to avoid a business which does not have a strong social or environmental process, they are however likely to place a higher multiple on these businesses.”

According to Brierley, OMMM monitors ESG risks through its external corporate governance risk review, which takes place on an annual basis and through an ongoing interaction with managers: “During manager selection, poor ESG practices will affect OMMM’s manager ratings and rankings of these managers.”

Further adoption?

While industry experts agree that adoption of ESG principles has been slow in the industry, they also agree that there are certain benefits of sustainable investing. Brierley says: “This is a benefit to society, the planet and the sustainability of both in the long run. In business this it is only fair and equitable to all to follow proper principles and practices of good governance.”

Rentzke adds: “It allows and facilitates a long term time horizon which is typically where we should be looking when committing capital that is long term in nature such as pension fund assets. Not only do well run companies tend to perform better but where externalities can be priced in and the cost of those externalities reduced it will impact positively on the bottom line.”

The adoption of ESG principles is an issue that may be addressed by hedge fund managers in their investment mandate - Udesh NaickerThere are many issues to consider in relation to responsible investment and hedge funds. The fact thathedge funds, by their nature, are unlikely to be long-term investments make the alignment of long-termESG interests a challenge. Udesh Naicker, Head of Hedge Funds at the Financial Services Board of South Africa, concludes: “The adoption of ESG principles is an issue that may be addressed by hedge fund managers in their investment mandate. As the regulator, we do not prescribe issues that the managers must include in their mandates.”

Registration Login
Sign in with social account
or
Lost your Password?
Registration Login
Sign in with social account
or
Registration Login
Registration