At Allan Gray, we aim to be a great asset manager that integrates ESG well in our approach and decision-making, rather than an ESG-focused company that manages clients’ assets. In light of the release of our latest Stewardship Report, Duncan Artus discusses some of the environmental, social and governance (ESG) issues that were top of mind in 2022 and highlights the issues we are focused on this year.
In 2020, the world was turned on its head as COVID-19 surged across the globe. Three years later, the consequences of this pandemic are still keenly felt, compounded by the ongoing Russia-Ukraine war. As a result, 2022 was characterised by lingering and new supply chain disruptions, spiralling inflation, a cost-of-living crisis in many parts of the world, and growing recognition of the centrality of energy security to economic prosperity. Geopolitical risk also came to the fore as we continue to observe tensions rising between the West and the East and its allies.
This dramatic shift in landscape led to something of a “reckoning” for ESG issues and responsible investing. For the first time in years, common narratives on “good” and “bad” companies were challenged. Russia’s invasion of Ukraine highlighted the need for countries to be able to defend themselves and prompted questions around whether defence stocks should still be seen as negative and excluded from ESG funds. What about energy stocks, considering the requirement for energy security and that access to affordable, reliable electricity and heating is a crucial social need? Energy stocks saw a massive comeback after years of underperforming markets, while historically technology-heavy ESG funds had to reconsider their strategies as many high-growth, long-horizon technology stocks lost their shine in a rising rate environment.
For many years, we have tried to highlight the nuances and complexities of ESG and our concerns around several emerging trends that we believed warranted further consideration and scrutiny. We have also spoken out about our belief in the unintended consequences of fossil fuel divestment. It therefore came as no surprise that ESG debates intensified as the practical complexities of the enormous energy trilemma we face – how to achieve secure energy, ensure it is affordable, and lower its carbon profile – were laid bare. We were also pleased to see regulators taking an interest in ESG data and rating providers and the quality and transparency of their analyses, given their growing influence in the market.
In the US and globally, we saw companies re-evaluating their memberships of ESG-affiliated initiatives based on Republican pressure and the threat of litigation. In addition, some ESG-affiliated initiatives have increased their required membership commitments, while in other cases members underestimated what was required to adhere to the commitments. We have been careful not to join a plethora of third-party initiatives for some of these reasons, instead focusing on developing our own path to guide our ESG commitments to clients. We try to provide visibility around our commitments and how we approach these in section 3 of our latest Stewardship Report.
South African political and social risks remain top of mind. Loadshedding in 2022 proved how years of corruption and mismanagement at Eskom will continue to throttle the South African economy unless tackled with an urgency and governance overhaul that we are yet to see. Loadshedding, in turn, has multiple knock-on implications, such as affecting our already-compromised water quality by straining ailing water infrastructure. But Eskom is not alone. Across a swathe of state-owned enterprises (SOEs) and government-run institutions, poor governance and service delivery failures are impacting roads, rail, ports, healthcare and education. Companies report that sophisticated criminal syndicates and self-appointed “business forums” are increasingly hampering their day-to-day operations – a huge burden on companies that are trying to operate ethically and contribute to much-needed job creation and economic development. Economic deterioration and growing poverty are likely to increase the incidence of crime. All in all, South Africa’s risk profile has increased.
However, the risk profile has arguably heightened in every region globally. As bottom-up stockpickers, we are used to seeking investment opportunities within a broad range of macroeconomic backdrops. Risk management that is cognisant of macro and issuer-specific ESG risks is an inherent part of investing, and we believe there are numerous companies operating in South Africa that are navigating the macro risks well.
We further recognise the importance of positioning our clients’ investment portfolios to be resilient under multiple scenarios that could play out, such as a substantially deteriorating South African macroeconomic environment, persistent global inflation and accompanying rate rises, a severe slowdown in economic activity in China, or a world that divides along geopolitical lines.
Our 2023-2025 ESG performance and engagement commitments, highlighted in section 4 of our latest Stewardship Report, provide a base for our 2023 focus areas. Key themes were set in early 2022 and these are biodiversity and climate change, mineworker safety, and holistic governance assessments. However, as stated earlier, we must be responsive to changes in the global and local environments. Accordingly, we will add South African water and evolving social risks (particularly labour-related) to our research agenda. We also plan to improve our documentation on state capture, ensuring that we closely investigate any directors up for election who have been linked to entities where misconduct occurred.