Edition: April 2016/ June 2016


ESG via index tracking

An undertone of political interventions contrasts with trustees’ primary duty.

A new trend in the passive investment space is the growth, no less in SA, of benchmarks offering Environmental, Social & Governance(ESG) principles-led mandates.

Judith Rodin, president of the Rockefeller Foundation, recently wrote in Fortune: “For generations, shareholders have warned corporate managers not to let ESG responsibility eat into their profits. But a growing cohort of investors is sending a new message: ‘Do good, or we’ll walk.’”

Her research shows that this is no idle threat. Between 2012 and 2014 global assets managed according to ESG principles doubled to more than $6 trillion.

It is just the start. Amongst millennials – a demographic group that will inherit more than $30 trillion over the next few decades – 92% believe that a company’s competitive edge and profitability will be enhanced by investing responsibly. As a result, companies are reimagining how they source, operate and innovate to advance a healthier planet, which they believe will ultimately produce higher returns for their investors.

Anticipating this trend, MSCI led the market by launching the first ESG index in 2007. Today it has 200 dedicated ESG analysts who rate the 2 400 World & Emerging Market companies. The team annually produces 30-page reports on each. To minimise tracking error relative to the original MSCI market capitalisation indices, stocks are ranked within each sector.

Per sector, 50% of the worst-ranked stocks are then removed. This methodology therefore doubles overweight exposure to management teams that are demonstrating ESG leadership within their peer group. This translates into a low-risk strategy with potential average annual excess returns above the MSCI ACWI of approximately 1%.

What criteria determine whether a company is included or excluded in an ESG index? Essentially companies making genuine ESG efforts to positively impact the world tend to reap far more profitable rewards than companies behind the curve. This is illustrated by two examples.

At Starbucks, included in the MSCI World ESG Index, founder Howard Schultz had stepped away from day-to-day management in 2000. By 2007, the company was in a terrible downward spiral. Stepping back in 2008, Schultz ascertained that Starbucks had become soulless. Core to his turnaround strategy was a belief that “consumers are willing to walk another block and spend a little more for companies whose values they truly trust”. He went about restoring the company’s soul by investing in its staff and ignoring short-term quarterly earnings calls.

Chambers . . . pressure and profit

Given the economic slump, Schultz was under huge pressure to cut costs by removing healthcare benefits typically not offered to hourly-paid workers. Not only did Schultz refuse but he also started offering four-year online bachelor degrees via Arizona State University to all full- and part-time employees – that’s 140 000 out of a total of 191 000 employees – and there is no obligation on them to remain at Starbucks after graduation.

So don’t be surprised by their new-found enthusiam, and success, to sell you a $4 pumpkin latte.

By contrast take Walmart, excluded from the MSCI World ESG Index, where $7,8bn is the estimated salary contribution that the US government is indirectly paying to Walmart via social subsidies provided to its 500 000-strong American workforce. The subidies include food stamps, housing, childcare and healthcare grants. Clearly, something is out of whack.

These employees have jobs but are paid below the breadline. They’re seen by management as a cost driver not as a sales driver. Their morale, productivity and customer service is poor and Walmart’s competitors, such as Costco, continue to eat the lunch of the world’s largest retailer.

As a result of this – as well as public, government and investor pressure – Walmart recently increased its employees’ minimum wage to $9 an hour. It will have a significant impact on operating profit, forecast to be down 8% for the year. So with this pay increase has Walmart’s business model become more sustainable?
The answer must be a resounding no. For perspective, Costco pays its workers more than double that of Walmart at over $20 an hour. Therefore, the hidden costs embedded with this business remain a huge concern.

But it is worth pointing out that, from an environmental viewpoint, Walmart is placing significant pressure on its thousands of suppliers to eliminate greenhouse gas emissions and to increase recycled material within its packaging. This is an example of a company getting it right in certain areas but wrong in others. Unfortunately for Walmart, inclusion in the MSCI ESG indices requires management to proactively tackle all the ‘E’, ‘S’ and ‘G’ components of responsible business.

For SA institutional investors seeking to support ESG investments by voting with their pockets, without taking on the risk material benchmark underperformance, ESG indices are increasingly providing a viable, cost-effective solution. At the same time, these indices offer a practical alternative to the unsustainable practices of many listed companies across the world.

– Craig Chambers, director of special projects, Old Mutual Investment Group.


Nkandla on the fringe

The query to SARS in your Gravy column (TT Dec ’15-Feb ’16) is perhaps best answered by precedent. The remarks about the taxation for improvements to the private house of a public official reminded me of a story I heard shortly after fringe-benefits tax was introduced in the 1980s.

Having problems with various parastatals (nothing new there!), the then-government of the Nats (as paranoid about security as the ANC government today) turned to the private sector for help. A certain leading businessman (Mr X) was duly seconded to head a vital parastatal.

On arrival at his new office, Mr X was told that three motor vehicles would be at his disposal. At any given time, should he need to travel anywhere by car, all three vehicles would have to depart simultaneously. He would be inserted into one of the vehicles, randomly chosen by security, and all vehicles would travel along different routes to the same destination. This seemed a bit over-the-top to Mr X, but he dutifully obliged.

A week later Mr X received a frantic phone call from his wife. His employer had sent to their home an army of construction workers who were uprooting trees, building high walls and turning their private residence into a Fort Knox. On calling the head of security, Mr X was told that he and his family were a high-risk hit for the then illegal ANC. It was the parastatal’s policy that its senior executives be protected at all costs.

A year later, Mr X submitted his tax return. It was rejected by SARS on grounds that it did not reflect his fringe benefits i.e. three motor vehicles and improvements to his home for which his employer had paid. Mr X objected, saying that he had no choice.

They settled when SARS eventually insisted that he pay tax on only one vehicle since he could travel in only one at a time. That Mr X had his own private vehicle, received as a fringe benefit from his erstwhile private-sector employer and on which he had already paid tax, apparently meant nothing.

Next came the “improvements”. Mr X argued that they had been the cause of much marital unhappiness. Their beautiful garden – his wife’s pride and joy – had been upended. Vast walls had made it impossible to see the garden from the street (as people could in those days) and cut of their house from neighbours.

Mr X called in landscape gardeners They planted new trees, redid the flower beds and made the monstrous walls less obtrusive. All this was done at Mr X’s own expense. Yet SARS still demanded that he pay tax on the “improvements” that the parastatal had effected.

Advisers then stepped in to show that the cars and improvements were part of the parastatal’s security guidelines, approved by cabinet and adopted by parastatals. Individuals had no say over what vehicles were at their disposal or whether the wall would curve graciously around their garden or march right across it. Security had decided, and that was that.

Fortunately for Mr X, the advisors did argue that parastatals’ security policy applied across the board to all persons above a certain level in management. The “improvements” could not be a fringe benefit because they were necessary steps to protect top management during perilous times. SARS conceded, and so no fringe benefits were extorted from said executive.

Unfortunately for present discussion purposes, however, the analogy ends there. Mr X already had a swimming pool, so there was no need to build a “fire pool”. Neither did Mr X have a country retreat which might have needed a cattle kraal or chicken run to ensure that the many guests he had to entertain would have the freshest eggs, beef and chicken available.

Thus our current president cannot fall back on Mr X’s experience of fringe-benefits tax, especially as I doubt that earlier presidents had similarly necessary improvements effected to their private residences at taxpayers’ expense.

Further, there does not seem to be any policy which ensures that the Number 2 in government is subject to similarly necessary improvements and security. If there were, it could then be argued that there is a government security policy that requires the head and deputy head of state to have country residences to protect them from the striking and delivery-protesting urban mob; such rural retreats to be adequately equipped with livestock and water and be suitably protected in the event that no supplies can get through, or our Number 1 or the Number 2 could otherwise starve to death.

That is a very real threat as, according to reports last year, there is insufficient fuel for the SAAF to fly its aircraft. So who would send in helicopters with such much-needed supplies? The Guptas?

– Trevor McGlashan,