Sustainable investing: Balancing returns and responsibility

By: Eugene Botha, Head: Research Hive at Momentum Investments

In recent years, sustainable investing has emerged as a pivotal strategy in the financial world, driven by the growing recognition of the importance of environmental, social, and governance (ESG) considerations. In the latest edition of Mindfields, our research publication, we delve into some of the aspects of sustainable investing, drawing insights that explore the integration of ESG criteria (with a special focus on carbon emissions in South African equity), the challenges and opportunities in the South African market, the role of stewardship, and the misconceptions surrounding sustainable investing and returns.

Carbon emissions in the SA equity market

The South African equity market presents unique challenges for sustainable investing due to its size, concentration, and carbon intensity. The first two articles in Mindfields focus on carbon emissions in the South African equity market. The first article reviews how we report the carbon emissions of the portfolios that we manage relative to the benchmark. This is a vital first step in the process of managing the environmental component of ESG. It discusses the measures used in the report and the guidance that it provides to us and our clients as to how we are doing right now on this ESG dimension. While it provides a sense of the relative stance of a portfolio against the benchmark, it does not, however, tell us how to improve it.

The second article discusses the cost of managing carbon emissions through exclusion as well as the setting of benchmark-relative targets in the portfolio construction process. It evaluates the impact of these measures on the pureness of the factor premia you can extract out of the market and the resulting risk-adjusted returns that a portfolio might generate. The article concludes by advocating for engagement with carbon-intensive companies to encourage emission reduction rather than excluding them from portfolios. This approach aligns with Momentum Investments broader strategy of integrating ESG criteria to enhance long-term investment performance while addressing specific challenges in the South African market.

Stewards of investment success

Stewardship plays a crucial role in responsible investing, as highlighted in the third article in the publication. Stewardship involves the portfolio manager acting as the owner of an asset by engaging and voting with investee companies or investment managers to ensure sustainability. This approach emphasises the integration of ESG issues into investment decisions to protect investments and drive positive change within companies.

An approach of stewardship and engagement goes a long way to circumvent some of the challenges faced in a concentrated and carbon-intensive economy like South Africa. Transparency and accountability from both investee companies and investors are essential to facilitate informed decision- making and ensure that investments align with sustainability goals.

Investors implement stewardship in their investment portfolios through several practical steps, including active engagement, proxy voting, collaborative initiatives like the Principles for Responsible Investment (PRI) and the Carbon Disclosure Project (CDP), ESG integration in investment analysis, transparency and reporting, setting ESG targets, and engagement with Policy Makers.

Balancing sustainability and returns: What investors need to ask

The final article is a contribution from our strategic global investment partner – Robeco. They have been pioneering the integration of ESG factors into investment decisions. In this article, their head of sustainable investing, Carola van Lamoen, points out that it is no longer a niche practice but a mainstream approach that should enhance risk-adjusted returns over the longer term. The article challenges the false dichotomy of what is often seen as having to choose between sustainability and attractive returns. It emphasises that the correct question should focus on how much risk is acceptable to generate returns, while aligning with clients’ impact preferences. Research shows that ESG integration can act as an early warning system for risks not yet reflected in asset values, thereby enhancing investment performance. For instance, in equities, ESG issues influence more than 50% of investment decisions, highlighting the material value of integrating sustainability into investment processes.

We believe that the integration of ESG factors into investment decisions is a powerful tool for enhancing risk-adjusted returns and aligning investments with positive societal impacts. By focusing on the right questions and adopting a holistic approach to ESG integration, investors can achieve both financial and sustainability goals, contributing to a more sustainable and resilient financial system, and ultimately contributing to a more sustainable and equitable world.

To read more about the Research Hive at Momentum Investments, visit our website at momentum.co.za.

You can also download the latest Mindfields here.