Edition: March / May 2017
Editorials

RESPONSIBLE INVESTMENT

‘Sin stocks’ are okay

If you like smokes and drinks – for your fund’s investment portfolio, that is – go for them. Adrian Bertrand, head for Africa & Middle East of the PRI, explains why his organisation is comfortable.

So you thought that the class action launched by two pensioners – against the Transport Pension Fund, Transnet Second Defined Benefit Fund and Transnet itself – was a noise to grow faint in the mists of time? Wrong! Although it’s taken ages to get out of the ground (TT Sept-Nov ’14), out of the ground it is now in an action that involves way over R200bn.

A common misconception when considering incorporation of environmental, social and governance (ESG) criteria into investment decisions is that such commitments require a pension fund to divest from certain categories of investments. Often labelled “sin stocks”, they’d include the shares of companies in the tobacco and liquor industries.

Bertrand . . . no prescription

Let’s clear the misconception. Responsible investment – as per the principles of Regulation 28 and the Code for Responsible Investing in SA (CRISA), as well as the UN-backed Principles for Responsible Investment (PRI) – require SA institutional investors to consider ESG issues as part of their decision-making process before and during their investment in any asset. This speaks to the investment process followed rather than specific individual investments and/or investing in ESG-labelled products.

The Preamble to Regulation 28 of the Pension Funds Act states: “A fund has a fiduciary duty to act in the best interest of its members whose benefits depend on the responsible management of fund assets. This duty supports the adoption of a responsible investment approach to deploying capital into markets that will earn adequate risk-adjusted returns suitable for the fund’s specific member profile, liquidity needs and liabilities.

A fund has a fiduciary duty to act in the best interest of its members whose benefits depend on the responsible management of fund assets.

“Prudent investing should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an ESG character. This concept applies across all assets and categories of assets and should promote the interests of a fund in a stable and transparent environment.”

It’s therefore clear that the expectation on funds is to deploy capital into markets (companies and other investment vehicles) that will earn adequate risk-adjusted returns suitable for the fund’s specific member profile, liquidity needs and liabilities. A fund is well within its right to screen out investment into identified companies or sectors where there may be ethical concerns such as tobacco, alcohol, gambling, pornography and weapons manufacture.

Typically, many faith and religion-based funds – for example, those that are Shariah-compliant – choose to screen out such “sin stocks” from their portfolios. Their decision-making is based on the funds’ ethical codes and requirements.

The general RI principle is that investors must be aware of any material risks around the companies in which they invest. The PRI doesn’t tell its investor signatories where they may or may not invest. Neither is there a requirement that they screen out “sin stocks”.

However, the PRI does tell them that they should address the fact that investments in certain stocks such as tobacco, weapons manufacture and carbon-intensive industries like coal mining might not sit well with an increasing number of socially and environmentally aware fund members. More and more, institutional investors internationally are being pressured by their members to divest from industries seen to have a negative impact on society and the environment.

Retirement funds need to work at the balance between earning adequate risk-adjusted returns and being responsive to the ESG concerns of their beneficiaries. In SA, where the universe of JSE-listed stocks is relatively small, it is particularly difficult for funds to walk away from certain stocks even if they wanted.

The likes of BAT and AbInBev spring to mind. They’re virtually must-haves because of their respective sizes and liquidity, not to mention their consistent performance records. International funds, on the other hand, have almost limitless investment choices.

Given the SA context, active ownership of investee companies is a more practical strategy than negative screening. Engagement with company boards and managements on specific ESG or ethical issues is usually preferred to divestment.

Pension funds’ boards of trustees should therefore have in place policies that guide their mandates to investment managers on ESG and ethical issues. There might well be differences of opinion between fund members, but at least there’d be a transparent policy that they can debate and help to develop.