Responsible investing in action: Practical insights from a fixed income perspective

As a fixed income manager, we have an important role to ensure that our clients’ capital is deployed in a responsible manner to sustainable enterprises that earn an appropriate risk-adjusted return. We are part of the broader capital allocation mechanism in South Africa that contributes to the socio-economic growth of our country.

Futuregrowth is one of the largest institutional fixed income managers, with R198bn* of assets under management, and a track record of 30 years. Approximately R35bn of our AUM is invested in a range of developmental impact funds. This allows us to participate in high-impact infrastructure sectors (water, renewable energy, transport, healthcare, education, etc.) and developmental sectors (like agriculture, affordable housing, SMME finance) that are key to socio-economic growth.

Risk return

As capital allocators, we identify risks that could potentially erode value and price for these risks. Therefore, investing in sustainable enterprises is key to ensuring the appropriate long-term risk-adjusted returns for our clients. A key part of this is understanding the risks and sustainability practices of the entities that we fund. Each investment is unique and there is no ‘one size fits all’ when assessing non-financial risks. Analysts have access to analytical tools, frameworks, scorecards, and research as an input, but it is key for them to apply judgment in assessing and making recommendations that will inform the rating and pricing of potential investments. It follows that entities with higher risk exposure will attract a higher cost of funding.

Promoting sustainability and ethical practices

A key part of our role is to promote sustainable and ethical practices within our sphere of influence. South Africa has a history of both corporate and SOE malfeasance. Over the past decade alone, we have witnessed firsthand the material impact of corruption on a company’s revenue, reputation, and overall sustainability. As a result, non- financial risks are no longer deemed ‘soft issues’.

Some important principles from Futuregrowth’s analytical work resulted in our SOE ‘Governance Unmasked’ report, released during February 2018, which highlights the following:

• Being a responsible investor implies that we make decisions to allocate capital to those sectors and entities that adopt transparent, sustainable policies and practices.
• Governance standards are not primarily there to control the ethical, but rather to constrain the unethical.
• For governance to be properly effected, we need the appointment and retention of people of the highest competence and unimpeachable integrity. To ensure we promote sustainable and ethical practices, it is important to build investment processes that embed institutional memory, that recognise patterns, trends, and red flags that support the investment thesis, analysis, and decision-making process. In addition, bond holder engagement is a key aspect of the overall process to manage risk and provides an opportunity for investee companies to adopt practices that can promote their long-term sustainability. Bondholder engagement In some instances, appropriate milestones and timelines are negotiated and included in the legal agreements to measure and monitor change. Some engagement areas are driven by socio-economic demands:

• Due to the urgency of the climate crisis, there is greater emphasis on climate mitigation (seeking ways to prevent or reduce emissions) and adaptation (seeking ways to adapt to a future state that considers the impact of climate change). Investors are seeking innovative solutions that leverage technology to address social and environmental challenges, such as clean energy, energy efficiency, smart cities, and sustainable transportation. This could include investments in sustainable and regenerative agriculture and other sectors that support a low carbon economy.
• There is also a growing recognition of the importance of diversity, equity and inclusion (DEI) as investors seek companies to prioritise DEI as part of their overall transformation strategy. Companies that operate in sectors where this is a priority, risk their license to operate if not addressed as part of an intentional strategic objective. These can present both risks and opportunities, which are identified as part of the due diligence and risk assessment and will inform and guide the engagement approach with a company. Industry engagement and collaboration There is an opportunity over and above individual engagement for broader industry engagement and collaboration. A recent example where Futuregrowth actively engaged was on the National State Enterprise Bill and the Public Procurement Bill. We engaged directly with the respective government entities, as well as through ASISA. As institutional investors, we all have a part to play in influencing our local economy and

building a more sustainable future by engaging in these important issues on behalf of our clients.

We should never compromise on achieving sustainable risk-adjusted returns for our clients. Each investment is unique and there is no ‘one size fits all’ when assessing non- financial risks. As part of our fiduciary duty, both financial and non-financial risks need to be assessed and taken into consideration and priced for appropriately.

Engaging and promoting sustainability and ethical practices is our collective duty, to ensure a better future for all.