ESG – merely measuring or driving real change?

BY MOHAMED MAYET CEO and Portfolio Manager, Sentio

ESG has possibly become the most oversold and misunderstood concept in the investment world. The reasons seem simple: demand from institutional clients who are under pressure from asset owners to show they are doing ‘something’ to be good stewards of capital; and pressure from younger retail audiences (Gen Z and millennials) who genuinely want to be better humans. But this often leads to inauthentic practices by fund managers to ‘do the right thing’. The result: we think we are doing good when in fact we’re not doing much!

Our mantra at Sentio is ‘invest for good’ – not only because we think investing can be a positive change driver in society (the greater good) but also because our industry can influence longer-term prosperity. Our approach to driving real societal change and positive alpha for investors is very practical and authentic.

What do we mean by practical and authentic?

Much of the ESG efforts currently being driven by gatekeepers seem to be well intentioned but obsessed with measuring. Measuring everything from Board attendance and carbon footprints to registers for ESG interaction. Institutions have set up entire departments to deal with the ‘ESG’ function. There is nothing inherently wrong with this, except we would simply ask: what are we doing with this data and information? We suspect the logic is ‘if you can measure it, you can manage it’. The problem is that, particularly in SA, the strategic framework behind this seems too biased towards the ‘feel-good factor’ and often lacks the financial return imperative. Requests for reems of data on ESG metrics alone, without any link to specific outcomes, in our view, will not achieve the desired outcome. Specifically, we would argue that the current approach of ‘measure everything’ misses the point of ‘what are we trying to achieve?’

So, what is ESG trying to achieve?

Our view on what we should be trying to achieve is the following: measure corporate behaviours and industry dynamics that result in adverse risks on all ESG factors, and link these to outcomes and their impact on investment risks. What we are looking for is a change in negative risks to society and ultimately to shareholders, and for these to constantly improve over time. You want polluters to find clean and efficient ways of doing business, you want businesses like mines to be invested in the communities in which they operate, and you want corporate cultures that reject bribery and poor governance. Why? Not because you want to show you measured it, but because it is a business and societal risk that results in poor performance and ultimately negative alpha and investment returns for all stakeholders. This is about practical change in risks, not the mere measurement of ESG data. In our view, ESG risks are becoming (and potentially already are) a compliance function relegated to a corner in the building.

We see ESG as an investment outcome and managing it leads to better alpha and better societal outcomes

At Sentio, we have fully integrated our proprietary ESG processes into our investment philosophy since inception. We see ESG as an investment outcome and managing it leads to better alpha and better societal outcomes. We managed to avoid the ESG ‘stock bombs’ of Steinhoff, Lonmin, EOH, Resilient and ABIL due to this framework and approach. Good ESG processes add alpha in the medium to long term (we have seen tangible results of this) and symbiotically also lead to a better society, but this requires an authentic approach that goes beyond a mere data collection and tick-box exercise.