Issue: Mar/May 2011


Slowly out of the ground

At least the SRI index is making companies, and investors, think. That in itself has value as 'integrated reporting' comes into its own. LISE PRETORIUS discusses where the index is going.

Since its launch seven years ago, uptake by investors of the JSE Socially Responsible Investment (SRI) index has been slower than its proponents would prefer. From the start, notes index head Corli le Roux, the drive was from corporates wanting a tool that could help them clarify sustainability issues.

The problem has been with the short-term objectives of investors, to show improved performance quarter by quarter and to consider SRI an asset class which constrains returns; in other words, a lack of buy-side support for the index.

Unlike such international prototypes as the FTSE4Good, which rely on "ethical" exclusions such as tobacco companies, the JSE's index leans towards engagement with companies. This approach recognises the reliance of the SA economy on mining and resources that, by the nature of their operations, impact negatively on the environment. And were these biggest and most liquid of JSE stocks to be excluded, the SRI index simply wouldn't be investable.

So, points out Le Roux, companies are classified as high, medium, and low impact in terms of environmental criteria: "A high-impact company will have to pass more stringent criteria than a low-impact company. It is also these high-impact companies that are the largest stocks by market capitalisation listed on the JSE."

It's now mandatory that stocks both in the JSE Top 40 as well as the mid-cap categories be evaluated for inclusion. For small caps it remains voluntary.Any company included in the index for one year automatically becomes part of the universe for the next. This, says Le Roux, contributes to consistency. At present slightly over 100 companies are monitored. The criteria are reviewed, but not necessarily changed, each year.

Why should investors bother with the SRI index when it pretty much replicates the Top 40 index? Rather as a flaw, suggests Le Roux, this should be seen as a comfort: "You'll know that companies in the index perform well on all the traditional criteria as well as on environmental, social and governance (ESG) criteria. You'll know that the constituents either have good sustainable practices or are being actively engaged on these issues."

Company research for the index is supported by UK-based Ethical Investment Research Services (EIRIS) and the Stellenbosch University business school. "Since the companies have been analysed according to triple-bottom line principles, we get a low-cost option for exposure to SRI companies," says Jean Badenhorst of Advantage which offers a tracking product.

Le Roux

Le Roux . . . persistence pays

To David Couldridge of Element, the index is mainly a starting point: "We take note of it, but do our own bottom-up analyses. You can't rely on any specific score. Around the world there are a number of organisations that develop ratings for governance, for example, which were shown during the financial crisis to be fallible."

He believes that more work must be done on the index. Importantly, climate change still needs to be incorporated.

Sharon Bailey of Prescient also sees the index as a starting point: "From here, a specific mandate from a client would place additional limitations and restrictions on the portfolio." Similarly, Cadiz and Metropolitan use the index with a house-valuation overlay.

An outspoken supporter of the index is John Oliphant, head of investments at the Government Employees Pension Fund: "Incorporation of ESG issues into mainstream investment decision-making is a trend that, as fiduciaries, we cannot afford to ignore. Companies that manage ESG risks perform as well, and often outperform, their peers."

At least the index is shining a light on the importance of sustainability, so vital for prudent long-term investors because matters such as carbon pricing, water scarcity and environmental management increasingly impact on company performance. It implies that much more work has still to be done on the index, says Heather Jackson of Cadiz, "but it's still early days for the index and the work it's doing is certainly worthwhile".

Companies that once doubted the value of the index, and took unkindly to the onerous paperwork in completing endless questionnaires, should now be grateful for it. With 'integrated reporting' that embraces ESG taking effect as a mandated JSE requirement, there could hardly be a more useful toolkit to guide them.