Fossil fuels on fire

By Old Mutual Wealth Investment Strategists Izak Odendaal and Dave Mohr

These strange times have become even more unusual. Despite the enormous efforts to reduce the demand for carbon-emitting fossil fuels, their prices have shot up in recent weeks.

The upcoming COP26 Glasgow Climate Summit could ironically take place against the backdrop of coal and natural gas prices at record levels and oil at multi-year highs even though the share of renewables in the global energy mix has thankfully risen steadily.

Chart 1: Futures prices for coal, gas and oil, US$

Source: Refinitiv Datastream

A perfect storm

It is a perfect storm of events that got us here. On a positive note, demand for energy has increased from the lockdown-induced lows. For instance, IATA estimates a 26% growth in airline passenger numbers between 2020 and 2021, though they are still more than 40% below 2019 levels. However, this improvement in demand has not been met by rising supply. On the contrary, several factors have constrained supply.

One is simply the weather. Northern Europe relies heavily on electricity from wind, but it has been less windy than usual. Droughts in Brazil, China and the US mean hydro-electrical production has also been lower than normal. This has led to increased demand for natural gas and coal. However, natural gas inventory levels have been lower than usual at storage depots across Europe. This has created an opportunity for Russia, Europe’s main gas provider, to flex its geopolitical muscles and go slow on deliveries, although it has indicated a willingness to stabilise the market recently. With winter looming, natural gas prices in Europe have gone stratospheric, pulling up prices in other parts of the world.

In China, flooding has disrupted domestic coal production. China is already the biggest consumer of coal in the world, but demand has increased recently, and with it, its price. Geopolitics play a role here too. China blocked Australian coal imports, about a tenth of its total last year, after Australia questioned the origins of the coronavirus. Imports from Mongolia have also been disrupted by Covid.

Chinese electricity prices are heavily regulated, and utilities cannot freely pass on the cost of higher coal prices to customers. Many have opted to cut back on production, rather than sell at a loss. Beijing has now announced that selling prices will be allowed to rise somewhat. All this has happened at a time when local governments were already reducing electricity production from coal to curb air pollution and carbon emissions. The net result is something South Africans know well: widespread load-shedding.

Finally, in terms of oil, OPEC (along with Russia) has largely maintained the production cuts it put in place last year to prop up the oil price. In other words, there is no fundamental shortage of oil. Supply is being deliberately held back. OPEC can increase supply if it worries that high prices will choke off demand, but for now, its members seem comfortable with the revenues flowing in. Importantly, the price increase has not yet led to the associated increases in American shale oil production as has been the case over the past decade. Shale producers have largely abandoned the old production-at-all-costs mindset in favour of maintaining profitability and shareholder returns.

Chart 2: US oil prices and production

Source: Refinitiv Datastream

An associated factor is that these companies and their peers face increased difficulty in accessing the funding needed to increase short-term (in the case of shale) and long-term production (in the case of the oil majors). Banks and asset managers across the world are phasing out exposure to fossil fuels and some have already cut all ties. This has contributed to steep declines in capital expenditure by fossil fuel producers. 

In other words, the big move among global investors towards embracing environmental, social and governance (ESG) principles might have the unintended consequences of higher fossil fuel prices until such time as renewable sources reach critical mass.

Chart 3: Capital expenditure by listed oil, gas and coal companies

Source: Refinitiv Datastream

The good news is that elevated fossil fuel prices do create a strong incentive to increase investment in alternatives. This is where ESG can play a big role to make sure the alternatives are green, not brown. Economists have long argued that the best way to tackle climate change is to put a tax on carbon emissions. This is because the price we pay for a tank of petrol, for instance, covers the cost of production and distribution but not the cost of the associated air pollution. Since the cost of this externality is not included, petrol is too cheap. This leads to excessive demand. A carbon tax raises the price to its “correct” level and lower demand. The recent price increases could therefore achieve a similar effect.

A tax on your houses

Increased energy prices act as a tax for most consumers. Most of us have no choice but to fill up our car. If you live in the snowy Northern Hemisphere, you have little choice but to heat your home with gas.

In other words, this will be a drag on global consumer spending, the question is just for how long will prices remain elevated. It is somewhat compensated for by the excess savings that households in the rich world have built up, but it also appears that most of the excess savings are concentrated in the hands of more affluent households. Meanwhile, it is lower-income households that are most exposed to increases in energy prices and associated rises in food prices. Nonetheless, it is worth pointing out that at around $80/barrel, the oil price is nowhere near the $150/barrel record set in 2008 on the eve of the global financial crisis, or the $100+ levels that prevailed between 2011 and 2014, especially adjusted for inflation or growth in incomes.

The other complication is that these price increases come at a time when inflation rates are already elevated. The global production and delivery of goods are already severely constrained by Covid-related disruptions, shortages of inputs and labour, and logistical bottlenecks. But now production in China, the world’s factory, has to contend with electricity blackouts. This is likely to worsen the supply chain problems already besetting the world economy.

People often confuse higher fuel prices with inflation. Fuel prices are very visible since most motorists have to fill up at least once a month. But inflation refers to sustained price increases in a broad range of consumer goods and services. Energy is a component in consumer price indices and therefore higher energy prices do have a direct short-term impact. But the big question is whether firms can raise their selling prices to compensate for higher input costs. In this way, higher energy costs ripple through the economy. If workers then demand higher wages to compensate, we have the beginnings of a wage-price spiral. This clearly requires pricing power on the part of firms and bargaining power on the part of workers that have been absent for many years. However, in the current Covid-distorted global economy, there have been signs of both.

Winners and losers

There are clear winners from this energy crunch. Net exporters of coal, gas and oil are clearly smiling, particularly countries such as Nigeria that have really struggled until recently.

In contrast, many countries are energy importers and face not only higher inflation rates, but also potentially balance of payments problems as they need to cough up more of their scarce dollars for each barrel of oil. Compounding matters, this comes at a time when the US Federal Reserve is planning to scale back its monetary stimulus, which has put upward pressure on the dollar. Some developing countries, therefore, face a triple whammy of higher energy costs, a weaker currency, and domestic central bank interest rate hikes aimed at stabilising exchange rates and inflation.

South Africa has one leg in this camp as an importer of petroleum products. The rand has been on the back foot in recent weeks, and this means a big petrol price increase is on the cards for next month.

However, we are also the world’s fifth-largest coal exporter (behind Australia, Indonesia, Russia and the US) and the rising export revenues limit downward pressure on the rand. Coal exports would be even higher if not for the capacity constraints on the Transnet rail corridor from the Highveld to the coal terminal at Richards Bay.

It also helps that inflation has been relatively stable in South Africa, with price increases excluding food and energy costs running at only around 3%. The SA Reserve Bank’s latest forecasts suggest that inflation should stay close to the 4.5% midpoint of the target range over the next two years. However, the risks are clearly to the upside. A gradual interest rate hiking cycle is therefore likely to commence in the next few months. How gradual will depend on where energy prices settle and how the rand responds. The Reserve Bank will also keep a close eye on what other central banks are doing, particularly the US Fed.

Oils well that ends well?

In summary, it is a delicate moment for the global economy, and could end up being a long, cold winter for people in the Northern Hemisphere. The big risks are a slowdown in consumer spending, further disruptions to production and persistent inflation that forces central banks to tighten monetary policy sooner than they’d like. None of this is good for markets.

However, it is worth repeating that the underlying cause is the strong recovery in demand as the world gradually puts the pandemic behind it. This is good. Moreover, energy prices are notoriously volatile. In April last year, a key oil futures contract briefly traded at a negative price. Traders were willing to pay to get rid of the oil rather than take delivery. The most recent price moves in gas and coal also have all the hallmarks of panic-driven trading, and therefore are unlikely to be sustained over time. Investors in diversified portfolios should similarly avoid making panicky moves in response to the recent dramatic headlines. The current situation is the result of a nasty confluence of events, and some of the contributing factors on the supply side could ease.

Finally, in the current context, it might be worth remembering that 13 years or so ago, “Peak Oil” was a dominant investment narrative. It was believed that the global supply of oil would peak and this justified prices surging to $150/barrel and beyond. The opposite turned out to be the case. Today, we’ve probably already passed the point of peak oil demand due to the rise of electric vehicles. Demand for coal could prove stickier, while natural gas could increase in importance as a “bridging fuel” while the world transitions to renewable sources. However, short-term price movements are clearly going to remain unpredictable.

This is relevant when thinking about investments more broadly. Dominant narratives can lead you astray. Just because you read about a “megatrend” or “structural change”, whether it is ESG, clean energy, blockchain, biotechnology, or demographic shifts, doesn’t mean that there is easy money to be made. It could be priced on already, or simply overhyped. You could be way too soon or too late already. Maintaining appropriate diversification across different asset classes and within each asset class remains the best way of investing, even if it sounds boring.

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Harnessing the power of ESG risk premia in systematic investing

Jessica Phalafala, Quantitative Analyst, Prescient Investment Management

Socially responsible investing (SRI) has undergone a profound evolution since its origins in colonial America, where religious groups abstained from investing their endowment funds into anything associated with the slave trade. Centuries later, it transformed into mutual funds screening out investments that were directly or indirectly associated with gambling, alcohol and tobacco.

SRI was further used as a tool to express the moral values of institutional investors and their support for historical movements. As a case in point, during the apartheid regime in South Africa, many global mutual funds screened out companies that were engaging in business in the country.

At the dawn of the 21st century came a heightened global awareness of the myriad of acute challenges we face as a planet, ranging from climate change, socio-economic inequalities, and the rise of unjust and exploitative institutions. This heightened the awareness of the need to introduce responsible investing methodologies that were significantly more extensive and far-reaching than the traditional screening approach.

The term Environmental, Social and Governance (ESG) investing was first coined by the United Nations Global Compact in 2004 and involved the systematic integration of these factors into the investment processes of financial institutions. ESG investing has since gathered significant momentum and continues to gain traction in line with the fundamental shift in investor perceptions as they recognise the material impact ESG factors can have on investment returns.

The United Nations-supported Principles for Responsible Investment (UNPRI) were launched in 2006, with just over 60 signatories representing $6.5-trillion in assets under management. Support for the UNPRI has since exploded, and now it has more than 3 000 signatories, representing $103.4-trillion in managed assets, all of whom are committed to integrating ESG factors into their respective investment processes.

This remarkable growth in ESG investing can be ascribed to the growing evidence that ESG-related performance may be a proxy for company productivity and stability, thereby providing an additional source of excess returns. Risk premia strategies have been used for decades in systematic investing as a method for harvesting excess returns.

This is achieved by investing in factors that have been proven academically and in practice to provide the investor with a positive payoff for undertaking the risk associated with each factor. Commonly used risk premia include the value risk premium, which is the excess return derived from companies that are trading at a low-price relative to their fundamental value; the momentum risk premium, which favours stocks that have displayed a sustained positive return trajectory over a given period; and the market risk premium, which is the differential between the market yield and the risk-free rate of return.

These factors have all been proven to yield higher long-term risk-adjusted returns. The overwhelming evidence confirms that using ESG factors in the portfolio construction and security selection process based on factor analysis and risk premia strategies allows investors to yield additional risk-adjusted returns.

The logic that value-creating ESG-related practices contribute to company outperformance upholds the thesis. For instance, a well-managed company that adheres to environmental and social regulations is less likely to face litigation, the higher costs associated with the management and disposal of hazardous waste and elevated employee injury rates.

Therefore, ESG factors may provide better insight into the probability distribution of company returns in the same way as the traditional risk premia incorporated in classical asset pricing frameworks. Also, ESG factors are strong candidates for inclusion in long-term factor investing. They display strong explanatory power over a wide range of securities, offer a positive payoff over reasonably long horizons, have a significantly low correlation with other factors and, above all, they make intuitive and economic sense.

In identifying ESG factors as risk premia, the systematic investor needs to move beyond traditional screening methodologies and policy implementation towards a rules-based, scalable and measurable ESG integration strategy. To do so requires practical, quantifiable metrics  that can be readily integrated into an existing investment process, together with other strategies to construct a well-diversified portfolio.

To this end, we have developed the Prescient ESG Scorecard which is an in-house risk analysis tool designed to evaluate and measure the ESG risks and opportunities associated with the credit and equity counterparties in which we invest. It is a data-driven and systematic scorecard that rates companies relative to their sector-specific peers while accounting for industry materiality and market cap biases. We employ over 60 metrics to gain granular insights into the proficiency of the ESG practices of the underlying counterparties.

Each of the metrics is conscientiously identified and selected to address a broad range of globally recognised material ESG themes. These themes include board and workforce diversity, board structure, water usage, greenhouse gas emissions and the safety of employees, to name a few. A combination of extensive ESG research, active engagement with our investees and this cross-sectional scoring tool has significantly enhanced our ability to integrate ESG into our investment process alongside the traditional risk premia we consider. It also enables us to interrogate practices that historically eluded systematic investors.

The last decade has seen ESG find a permanent place in everyday investing. Its rise in popularity has shown no signs of slowing down, with Bank of America forecasting a “tsunami of assets”, as much as $20-trillion, flowing into ESG funds in the US alone over the next two decades.

At Prescient, we believe it is  our responsibility to preserve our clients’ capital by deploying it in a manner that promotes sustainability and delivers on our goal to achieve superior risk- adjusted returns. We accomplish these two goals by managing absolute and relative downside financial risk, as well as non- financial operating risk. We consider ourselves well-equipped to deliver on these twin objectives given our comprehensive responsible investing philosophy and approach, as well as our expertise as a seasoned systematic investor.

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New fund focusing on renewable energy answers a need in South Africa

FUND FOCUSING ON RENEWABLE ENERGY, A SOUTH AFRICAN FIRST

With the saving and retirement industry recognising the important role it can play in bringing about social change by supporting South Africa’s infrastructure needs, there is a dearth of viable options available. As listed companies with a pure or major focus on the South African economy struggle to deliver returns to investors, the managers of retirement funds and other savings are now looking for alternative asset classes to obtain sufficient returns.

Says Dr Hendrik Snyman, chief investment officer at Gaia Fund Managers: “With the local stock exchange having underperformed over the past number of years and with limited options available, it is necessary for asset managers to be innovative in obtaining returns for their investors. Globally, there has been a trend whereby asset managers are looking to alternative assets to provide resilience to negative market movements, price irrationality or a lack of returns.”

“We are proud to offer a novel investment opportunity that combines assured, solid returns with sustainable energy, infrastructure and community ownership.”

Hein Kruger, managing director of Kruger International

Through the Kruger Ci Prudential, Balanced and Equity funds, clients can now invest in the operational wind farm in a safe, regulated and tax-effective way where the impressive returns inherently adjust by inflation each year.

“Kruger’s co-investors in the wind farm near Humansdorp in the Eastern Cape include the Tsitsikamma Development Trust (9%) and Cennergi (75%), a wholly-owned subsidiary of listed company Exxaro Resources. This is a true ESG (environmental, social and governance) investment. The community trust receives investor returns for their shares. The construction has already benefitted the local community through infrastructure upgrades, a new community centre, cattle fencing and bush clearing. Since then, the wind farm contributes 2.1% of its revenue quarterly to enterprise and socio-economic development in the surrounding communities.”

The wind farm is a renewable energy project with an installed capacity of 95 MW, situated near Humansdorp in the Eastern Cape’s Koukamma Local Municipality. It became operational on 17 August 2016, offering a measurable track record in output performance. This project and its various service providers have met and exceeded expectations with the power produced since operations started, surpassing the P50 (base case) forecast. The performance of the project to date reflects the quality of the wind resource, equipment and service providers, according to Snyman.

The listing of the Company’s preference shares, with its focus on clean energy, takes place as the South African Government ramps up the supply of renewable energy to the national electricity grid. On 25 September 2020, the Minister of Mineral Resources and Energy, Gwede Mantashe, gazetted a key determination under national legislation to procure a total of 11 800 MW of electricity, of which 6 800 MW will be from renewable sources.

“This investment contributes to much-needed infrastructure in South Africa and investment diversification in an alternative asset class for us as the investors. We are proud to include Gaia Fund 1, with the wind farm as its first asset, in the Kruger funds,” says Kruger.

Collective Investment Schemes and retail investors have struggled to directly access infrastructure investments for several reasons. First, they are not readily available. Second, they are not usually listed on stock exchanges. Lastly, those options which are listed are subject to deflated prices owing to the lack of a readily traded market that understands the underlying principles of the asset class.

Snyman explains: “Infrastructure as an asset class can provide investors with stable inflation-linked cash returns while preserving their capital. However, the current means of gaining access to these projects includes a daunting and protracted process requiring, among other things, negotiating lengthy contracts. This process is far removed from investors’ ordinary means of acquiring shares on a trading platform and, therefore, acts as a significant investment barrier to entry and exit. In addition to the process, the unlisted equity available in the projects precludes certain Collective Investment Scheme portfolios from acquiring interests in the projects. A listed security removes many of the entry and exit barriers for investors and allows infrastructure to take up its rightful place as an asset class in many investor portfolios.”

As a listed entity, the Fund will enable collective investment scheme portfolios to increase their allocation to infrastructure from an unlisted instrument threshold of 5% to 10%, yet retain the benefits of being unlisted through price stability. The ability to do this will open a unique market opportunity for future collective investment scheme-compliant portfolios to invest in 4AX-listed infrastructure projects through new issuances of preference shares in the Gaia Fund 1.

“Kruger International as an innovative fund manager collaborated with Gaia Fund Managers as a pioneer in the infrastructure investment space in South Africa to come up with a solution to access infrastructure investments for their investors,” adds Snyman. “Kruger International’s funds will hold all of the preference shares, allowing them to accurately mark their value on a daily basis; meaning that as an asset manager, they are less exposed to market irrationality and/or information asymmetry.”

Gaia Fund 1’s A preference shares will be 4AX’s seventh equity listing. 4AX, as a new low-cost, fully licensed equity and debt exchange, took up the challenge with Kruger International and Gaia Fund Managers to list these industry-first preference shares. 4AX provides security for investors, giving the required financial transparency and regulatory oversight without the obstructive burden and costs associated with legacy exchanges. As such, the cost and admin associated with listing are no longer prohibitive.

According to Eugene Booysen, CEO of 4AX: “4AX brings to the market an efficient and alternative regulatory model which reduces regulatory costs and inefficiencies but promotes and adheres to the highly regarded financial regulatory standards in South Africa. 4AX focuses on being a safe and simple digital marketplace redesigning finance and access to capital and thereby enabling inclusive growth.”

Gaia Fund Managers and Kruger International Asset and Wealth Management are pleased to announce the listing of South Africa’s first preference shares with an infrastructure focus on 4 Africa Exchange (4AX).

Gaia Fund Managers, together with Kruger International, plan to list Gaia Fund 1 (the Fund), which complies with Collective Investment Scheme regulations next week Thursday (22 October). The Fund’s A preference shares will trade under the ticker 4AGF1A (ISIN: ISIN ZAE400000101) on 4AX.

The preference shares will be bought by Kruger International’s various funds. The proceeds of the listing will be used by the Company to buy a 16% indirect shareholding in the Tsitsikamma Community Wind Farm.

For more information, visit http://www.gaia.group.

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Taking stock of Covid-19 through a sustainability lens

If you are reading this, you are well on your way towards surviving one of the most cataclysmic events of our lifetime; one that is forever going to reshape the way we view the world and drive home the importance of prioritising sustainability and all it entails during the years ahead.

The coronavirus, which originated in a wet market in Wuhan, China, in December 2019, has since been declared a global pandemic that has spread across the planet through international travel and global supply chains. At the time of writing, the number of cases worldwide was inching towards the 54-million mark. Additionally, the effects of the virus have reverberated through global financial markets and economies, resulting in the greatest recession since World War II.

The pandemic has also brought to bear the severity of socio-economic inequalities, risks introduced by our unsustainable systems as well as the materiality of fat-tail events. In so doing, it has provided us with an opportunity to redefine a new normal and introduce structural shifts that will help us work towards a sustainable future for all.

Many countries instituted national lockdowns at an early stage in the pandemic, which is a classic example of a suppression approach to pandemic management. The logic underpinning this methodology is to introduce social distancing to entire populations and minimise the number of additional infections reproduced by each confirmed case, thereby slowing the spread. This, ceteris paribus, is a highly effective public health risk management plan. However, in reality all other things are not, in fact, equal. Thus, the coronavirus has brought crucial attention to the social element of environmental, social and governance (ESG) issues.

National lockdowns entail the suspension of economic activity, which results in loss of income and employment, pushing the vulnerable segments of society, already on the precipice of poverty, into a state of destitution. Also, countries encumbered by acute socio-economic inequalities, like South Africa, have had to face the reality that large segments of their populations living in high population density areas and with inadequate access to clean water and sanitation would face a higher risk of exposure to Covid-19. The reality of the plethora of social risks has since powered the rollout of unprecedented global fiscal stimulus packages to soften the adverse economic effects of the pandemic.

Although these packages have provided the buoyancy required to see us through the immediate challenges, a fundamental shift in the discourse surrounding the risks fragile economic structures pose is translating into the development of a far more robust and well-defined path towards a sustainable future.

Consequently, sustainable investing will be a vital component of a post-pandemic recovery. For instance, there has been an increase in the global issuance of social and sustainability bonds over the past five years. New issuances in response to Covid-19 are also coming to market. A guidance note has been published by the International Capital Markets Association (ICMA) to provide a benchmark for the structuring and reporting standards associated with the new Covid-19 social bonds.

Domestically, the South African Minister of Finance announced plans to amend Regulation 28 of the Pension Funds Act to improve the ease with which retirement funds can finance infrastructure projects to help kickstart economic development.

The establishment of a robust regulatory framework and the dramatic increase in the need for social intervention worldwide will dramatically improve the level of interest in sustainability bonds and help reshape the economy of the future.

Companies adapting to change

Specific sectors and individual firms have been impacted in varying ways by the pandemic. When governments instituted lockdown laws, the spotlight turned to company governance practices and how executives would navigate the crisis.

Corporate boards faced scrutiny from various stakeholder groups that challenged the shareholder-centric model of governance, thereby making the board decision-making process much more multi-faceted. Companies became more cognisant of the central role they play in maintaining the socio-economic well-being of society through sustained value-creation. They also recognised how a well-functioning society puts them in a better position to meet their key performance indicator targets.

As a result, many boards decided to suspend or reduce their dividends and bonuses due to uncertainty regarding the scope and duration of the crisis. From an environmental perspective, working from home policies shed light on the environmental impact of commuting workforces. According to the International Energy Agency, a record drop in emissions is expected for 2020, with a projected 7% decline in energy-related CO2 emissions relative to 2019. Cities across the world have experienced lower smog levels, reduced water pollution and restored biodiversity highlighting the benefits of working remotely.

As such, many companies, like Microsoft, have implemented these policies permanently. Research also shows that infectious disease transmission is precipitated by rising temperatures, loss of biodiversity and other elements of climate change. By acknowledging this interconnectedness, global corporations are now playing a pivotal role in mitigating climate change risks.

Another equally crucial indirect consequence of the pandemic is the shift in focus to the social component of the traditional business model. Corporate culture measures such as employee health and safety and labour practices, including paid sick leave, have become priority areas and subject to intense public scrutiny.

Furthermore, severe supply challenges have also highlighted the risks of globalisation, and many companies have since amended their supply chain management processes to better diversify suppliers and reshore production. These social developments will not only improve working conditions but foster job creation and enterprise development.

Investor awareness on the rise

In light of the pandemic and growing public awareness of the climate crisis, investors across the world are shifting from a morally agnostic investment approach to one that aligns with their ethical concerns. This is evidenced in budding investor appetite for sustainable products, which has resulted in record-breaking flows into ESG funds in 2020.

Companies with strong ESG profiles have shown resilience in this time of crisis by staging a strong recovery post the March market lows.

This has prompted investors to rethink the impact ESG considerations may have on their investment returns. As supporting evidence, the MSCI World ESG Leaders Index has delivered returns in line with the MSCI World Index within a tight tracking error, other than its marginal outperformance in the wake of the March 2020 crash. This is a comforting return profile for the passive but ethically driven, investor.

Sustainable practices, such as strong incident risk management, fair labour practices, stakeholder-conscious boards, and clear decarbonisation pathways, have proven to be factors that drive long-term sustainable returns. To this end, we should witness an acceleration in the incorporation of ESG considerations into traditional valuation and risk models.

Forging a path forward

The turbulence caused by the pandemic and its indirect consequences has emphasised the need for global social change, multi-stakeholder centric business models, and international cooperation on public health and climate change considerations. This provides us with the carte blanche to rebuild a sustainable future for all and a resilient global financial ecosystem. The question is, which side of history do you, as an investor, want to be on?

Jessica Phalafala, Fixed Income Quantitative Analyst, Prescient Investment Management
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GBCSA’s +Impact Magazine in conversation with Old Mutual

GBCSA's + Impact Magazine in conversation with Old MutualWith Greeneconomy.tvHost: Byron Mac…

Posted by GreenEconomy.Media on Tuesday, 13 October 2020

+Impact Magazine speaks to Old Mutual about sustainable investment. Presented on GreenEconomy.TV.

GreenEconomy.TV provides insight and intelligence on all sustainable matters.

GreenEconomy.TV Host: Byron Mac Donald and GreenEconomy.Media Publisher: Gordon Brown speak to Old Mutual South Africa Head of responsible business: Khanyi Chaba

+Impact 0.7

+Impact Magazine, the 2019 SAPOA award-winning publication and the official publication of the Green Building Council of South Africa (GBCSA), offers best-of-class interactive digital publishing to a loyal network of like-minded readers from across the property value chain. We highlight the positive impact that sustainable buildings have on urban precincts, society, and on the economy while returning maximum value to investors.

GreenEconomy.Media is a multi-media publisher with South Africa’s leading green economy portal and social media. GreenEconomy.Media publishes +Impact Magazine.

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ESG: vital for robust investment strategies

Growing investor awareness and the willingness to engage in issues related to sustainability, combined with the increasingly vivid positive relationship between sustainable practices and financial performance, have cemented ESG considerations as an integral part of any robust investment strategy.

According to data from Morningstar Direct, more than $10 billion of assets in the US have been directed towards investing in sustainable funds during the first quarter of 2020 alone. These record-setting levels of flows underscore the growing significance of Environmental, Social and Governance (ESG) considerations when making investment decisions. Growing investor awareness and the willingness to engage in issues related to sustainability, combined with the increasingly vivid positive relationship between sustainable practices and financial performance, have cemented ESG considerations as an integral part of any robust investment strategy.

At Prescient Investment Management, our investment philosophy is capital preservation and the pragmatic management of funds. We systematically take on only those risks that have proven to deliver commensurate returns over time. We adopt a holistic and integrated approach to our investment considerations, ensuring that we deploy our clients’ capital in a manner that promotes sustainability.

We have embedded ESG integration into our investment process; our product development, the suite of ESG-centric products we offer, and our corporate culture. Prescient follow rules-based security selection and portfolio construction methods that are designed to capture excess returns by investing in those factors (sometimes referred to as smart-beta) that are proven to provide positive payoffs in the long term. Common examples of such factors are Value, Low Volatility, Quality and Momentum.

The recent proliferation of ESG as an undeniable driver of return. the consistent debunking of the historically held perception of an inverse relationship between financial returns and sustainability has made it clear that ESG can also be added to the list. We have developed a systematic and data-driven in-house ESG risk-analysis tool that evaluates and scores listed securities based on their ESG risks and opportunities.

The Prescient ESG scorecard consists of three pillars, namely: Environmental, Social and Governance. It considers material themes such as (but not limited to) diversity, board structure, emissions and energy consumption by appropriately selecting and categorising over sixty underlying metrics. This fully automated and rules-based scorecard accounts for industry materiality and company size biases and provides a granular and in-depth measure of the proficiency of the governance practices as well as the environmental and social impact of our holdings.

At a product development level, the Prescient Clean Energy and Infrastructure Debt Fund has been specifically designed to encompass our sustainable investing philosophy and impactfully deliver on our ESG targets. It participates directly at the project level of the Renewable Energy Independent Power Producer Procurement (REIPPP) Programme. The Fund seeks to invest in clean energy and other infrastructure projects that will have a positive social and environmental impact. The target is to build a well-diversified portfolio of infrastructure investments that will improve the sustainability of our energy supply and provide the infrastructure that is vital for the development of South Africa.

We strive to uphold and incorporate the same ESG values and principles that frame our product development and investment process at our corporate level. As South Africa’s largest black-empowered asset manager, we deem transformation and Broad-Based Black Economic Empowerment to be paramount in achieving economic inclusion and a sustainable business topography in the country. We take sustainability considerations into account when allocating brokerage services, for example, as well as in any of our enterprise development undertakings.

We remain sensitive to the fact that our country is encumbered by an array of socio-economic challenges, as is reflected by our high levels of inequality and unemployment. As a corporate response, the Prescient Foundation embarks on various projects and social upliftment initiatives to address the social issues that face many South Africans.

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Investment titans continue to get serious on ESG investments

Despite the short-to-midterm challenges of the global pandemic, the biggest challenge for multinational mining companies over the next decade will be responding to investors’ growing focus on environmental, social and governance (ESG) issues.

As a focal point of how seriously the extractives industries are now taking ESG investing, over the last year the Norwegian Sovereign wealth fund (SWF) has significantly cut back investing in oil and gas stocks. At the same time, the world’s biggest mining companies have made a series of disclosures designed to boost their credentials with more ethically minded and governance-focused investors.

To illustrate this, BHP, Rio Tinto, South32, Vale and Glencore have all published detailed analyses of the risks attached to their tailings dams. Rio published an extensive list of its contracts and commercial arrangements with governments, while BHP last year published a debut report into its global water consumption. Both Rio and BHP have published “taxes paid” documents in recent years, and both have faced shareholder resolutions seeking tougher stances on carbon emissions.

“The biggest question that all these companies have got to face is around ESG,” Evy Hambro, Chief Investment Officer within BlackRock’s natural resources equities team, recently told The Australian Financial Review.

”The amount of money that is going into ESG-related products is growing very rapidly, and how these mining companies navigate through them, and the changing ESG landscape over the next decade is going to be really important.”

Ratings agency Fitch says natural resources companies are more likely to have their credit rating affected by ESG issues than the broader corporate sector. About 22% of all companies rated by Fitch have their credit rating affected by ESG issues, but for natural resources producers that figure is closer to 31%. Fitch said ESG issues, such as water consumption and community relationships, were a ”potential driver” of BHP and Rio’s credit ratings. Both miners were given a score of three out of five by Fitch, under a system where companies ranked five have the most severe ESG issues.

”I think this whole footprint of resource production needs to be better portrayed by the companies so they can keep their place in the market,” said Mr Hambro, who has also discussed ESG points at Mining Indaba.

“It is about what is the impact of resource production, and how is it actually measured, what are the consequences of people consuming those resources.”

BlackRock’s World Mining Trust counts BHP, Rio and Vale among its biggest holdings. The trust also has Glencore and OZ Minerals among its top 10 exposures.

Fellow investment behemoth, Goldman Sachs, has famously begun overhauling its environmental policies, which includes pledging to spend $750 billion on sustainable finance projects over the next decade, as well as implementing stricter lending policies for fossil fuel companies. The $750 billion will focus on financing, investing and advisory activity related to nine key themes within climate transition and inclusive growth finance, which includes things like sustainable transport, accessible and affordable education and food production.

“There is not only an urgent need to act, but also a powerful business and investing case to do so,” Goldman Sachs CEO David Solomon wrote in an opinion piece published at the end of 2019 in the Financial Times. “Focusing on these specific goals gives us a set of metrics — such as the amount of carbon reduction and the number of people served — that we can track over time both for the companies and for ourselves,” he added.

Solomon said that companies no longer have the “luxury” of treating climate-related initiatives as a “peripheral issue,” and that financial institutions must support those driving change.

Goldman said that going forward, it will not finance any project that “directly supports new upstream Arctic oil exploration or development,” or any new coal-fired power generation project unless it also includes carbon capture or other emission cutting technologies. The firm’s prior policy only restricted funding in developed nations. The bank also said it will not back new thermal coal mine developments and that it will work with mining companies to help them diversify and cut emissions.

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