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ESG investing for the win

BY TAFARA MTUTU

GREEN investing has garnered traction over the past decade, and it has firmly established itself as a relevant investment theme after ESG-oriented funds breached the US$1 trillion mark in 2020.

This theme is also known by other terms such as impact investing, sustainable investing, or Environmental and social governance (ESG) investing. ESG is a set of standards that govern how companies and funds ensure that they are responsible in the way that they make profits.  It is a variation of the stakeholder model that businesses are increasingly adopting, which is founded on the stakeholder theory.

The stakeholder theory is a view of capitalism that highlights the importance of stakeholders such as customers, suppliers, employees, investors, and communities. In essence, the theory opens the capitalist’s profit-oriented mindset to other relevant considerations. In the case of green investing, these other considerations revolve around stakeholders that are affected by a company’s (i) carbon footprint, (ii) adherence to labour laws and support towards SDGs, and (iii) leadership, remuneration, and corporate governance.

The focus on ESG has been around for a while, but its relevance has been supported by several high-profile cases, a few of which are given below:

Volkswagen diesel scam

The automobile group was found guilty of cheating on US government emission tests and regulation in 2017. The scandal cost VW US$2,8 billion in penalties and over US$30 billion in fines, buyback, and financial settlements.

Deepwater Horizon case

An explosion at British Petroleum’s Deepwater Horizon drilling rig as a result of the company’s negligence made global headlines so much that it inspired the movie Deepwater Horizon. According to NBC News, BP paid US$18,7 billion in damages for water pollution caused by the spill, and settling claims with the U.S. government and Louisiana, Mississippi, Alabama, Texas, and Florida in July 2015.

Tongaat  Hulett

The company was the subject of an investigation by the Financial Sector Conduct Authority (FSCA) in South Africa after accounting irregularities led to surprise losses in 2019. According to reports, Tongaat Hulett’s “…previous account practices resulted in revenue being recognised earlier than it should have been, and expenses inappropriately capitalised to assets. This resulted in profits in the respective years being inflated and in the overstatement of certain assets in the group’s financial statements.” The group was slapped with a R20 million fine, and this was accompanied by a change in management.

Steinhoff saga

Tagged as one of the biggest cases of corporate fraud in Africa, this saga also unfolded when the sudden resignation of the CEO coincided with accounting irregularities that were noted. Steinhoff was fined R53 million (US$3,69 million), and former CEO Markus Jooste was fined R162 million (US$11,28 million) for his role in the company’s demise.

The losses incurred by the VW, BP, Tongaat Hulett and Steinhoff International not only impacted the company but also investors who had funds in these companies’ shares. Steinhoff’s share price fell from R55,62 (US$3,87) per share on November 27, 2017 to R9,57 (US$0,66) per share on December 11, 2017, and it traded R1,45 per (US$0,10) share on July 6, 2021.

Tongaat Hulett’s share price slid from R114 (US$7,94) on January 5, 2018 to R2,30 (US$0,16) on April 9, 2020. Currently, the counter trades at around R7,31 (US$0,50) per share.

VW’s shares also took a knock from €253.20 (US$299,42) per share on April 10, 2015, and it has struggled to recover back to that price level to date. BP’s share price also took a hit, but the business is one of the few that managed to swiftly recover.

These cases have begged a strong case for heightened focus on ESG as a criterion for investments. Therefore, ESG investing is no longer just a façade or a theme that funds consider to be beneficial for their brand, but it has become a fundamental point of focus for investors who acknowledge the materiality of unconventional risks that are usually not incorporated in traditional risk models.

Arbitrage Pricing Theory (APT), capital asset pricing model (CAPM), Value-at-Risk (VaR), beta, and standard deviation are some of the theories and models used to quantify risk in financial instruments. However, none of these models explicitly incorporate ESG risks yet these have proved to be material in the past decade alone. The major shortfall of conventional risk models is that they rely on historical data to quantify risk, and often neglect the possibility of infrequent but material events under the purview of ESG which can be identified by digging deeper into a company’s ESG analysis.

Fortunately, there are agencies that provide ESG ratings, which can be incorporated in investment analysis. Among the most prominent ones is Morgan Stanley Capital International (MSCI). MSCI’s ESG ratings framework incorporates (i) over 1000 data points on ESG policies, programmes, and performance, (ii) data on 100 000 individual directors, and (iii) up to 20 years of shareholder meeting results in generating exposure and management metrics. This data is then used to rank companies on a ratings scale ranging from CCC (ESG laggards) to AAA (ESG leaders).

VW is currently rated B, one notch above CCC, and BP is another two notches ahead at BBB according to MSCI’s ESG ratings tool. The tool currently does not provide ratings data on locally listed companies, but it covers some parent companies of businesses on local exchanges ZSE and FINSEC.

Old Mutual Zimbabwe Limited’s parent (Old Mutual Limited) is rated AAA and Delta’s parent company (Anheuser-Busch InBev SA) is rated AA, one notch below AAA. BAT Zimbabwe’s parent company (BAT Plc) and Lafarge Zimbabwe’s parent company (Holcim AG) are both rated BBB.

Mtutu is a research analyst at Morgan & Co. He can be reached on +263 774 795 854 or tafara@morganzim.com

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