IN RECENT years, the idea of analysing companies using more than just financial indicators has moved into the mainstream. Previously, such approaches were considered luxuries for ethical investors prepared to accept underperformance from their investments in exchange for a "feel-good" factor. But more recent research has shown growing awareness that environmental, social and governance (ESG) factors filter into the bottom line.
Responsible investing has emerged from the embryo of "socially responsible investing", which in turn originated from religious groups using a negative screening approach to avoid investing in companies whose core operations were incompatible with their beliefs. By contrast, ESG factors are primarily used in positive screening methods that identify investment opportunities that promote the principles of responsible investing.
In a recent research paper, Sustainable Investing: Establishing Long-Term Value and Performance, Deutsche Bank provides an overview of studies exploring the relationships between ESG factors and financial performance. It finds that where socially responsible investment (SRI) funds have taken a negative screening approach, the result is "mixed" in terms of the impact on financial outcomes. In contrast, it finds a positive outcome from most studies of the relationship between securities with high ESG ratings and financial outcomes.
In Blue & Green Tomorrow’s Guide to Sustainable Investment, Penny Shepherd, CE of the UK Sustainable Investment and Finance Association, argues that while funds taking a negative screening approach will remain part of the SRI and responsible investing landscape, the innovation in the field lies in funds that focus on the positive.
Nedbank’s Green Index and the related BGreen exchange-traded fund fit within this evolution of the next stage in responsible investing. Consistent with the Carbon Disclosure Project (CDP), the primary data source used for the index, the index takes a sector-neutral approach — it does not exclude any sector based on its activities.
At this stage in its evolution, the index is focused on climate change due to the stronger data in this area, and no company can escape the fact that it is contributing to carbon emissions and will be affected by climate change. So, every company can play a role in mitigating and adapting to climate change. Those that choose to ignore it will still not escape the consequences. As the data improve, the screening criteria will be expanded to include other similarly pressing issues, such as water.
The Green Index selects and weights constituents based primarily on the disclosure and performance scores assigned by the CDP. As a consequence of these scores, 17 of the 54 constituents in the index are mining and resources companies.
What makes a mining company ‘green’?
The CDP is an independent, UK-based nonprofit organisation that distributes questionnaires on climate change to companies across the world, including the JSE top 100. Based on the responses of the JSE 100, the report provides two scores for each company — one for disclosure and one for performance.
The disclosure score assesses transparency and accountability regarding climate-change-related issues and good internal data management practices. The performance bands focus on the framework that companies have put in place to address carbon management, and look at the ambition and success of a company’s short- and long-term actions to mitigate climate change. The CDP seeks to continually raise the bar for companies by making its ratings more stringent each year.
It is important to realise that both the CDP’s disclosure and performance scores are industry neutral, on the basis that all industries need to be encouraged to respond to climate change. Every industry faces unique risks and opportunities in the face of climate change, and only if companies across all industries respond to it can the government’s goal of achieving a "low-carbon, carbon-resilient" economy be reached.
In the CDP South Africa 2011 report, it says of the energy and materials sector, which includes the mining sector: "The sector has a significant climate-change impact, as well as high levels of vulnerability to the physical and policy effects of climate change." This highlights how critical it is that the mining sector responds to both the mitigation and adaptation aspects of climate change. Given South Africa’s dependence on the mining sector, if the companies in this sector fail to reduce their carbon emissions and adjust to a changing physical and regulatory environment, there will be serious consequences for the country.
Fortunately, many South African mining companies have made an effort to come to terms with climate change. To understand what kind of cognisance is taken by these companies in terms of the risk and opportunities presented by climate change, the following are examples of responses on climate-change risks and opportunities:
Platinum and precious metals
In May 2012, Anglo American Platinum launched a prototype of a mine locomotive powered by a platinum-based fuel cell. The company is seeking to show how fuel cells can improve energy efficiency and productivity through its own operations. It will begin surface-testing the prototype in the third quarter.
Exxaro has a joint venture with Tata Power in a cleaner-energy independent power producer, Cennergi, who received preferred bidder status in the second round of the government’s renewable energy rollout for two wind farms. It is also seeking to register three wind and two solar projects with the Clean Development Mechanism (CDM).
As part of Gold Fields’ integrated energy and carbon management strategic initiative, the miner has stipulated targets for renewable and alternative energy mixes. It has already spent about R60m on the Beatrix South Methane Project, which is estimated to reduce its methane emissions by up to 250,000 tonnes of carbon dioxide equivalent per year, and the Beatrix West project is under way to reduce emissions. Beatrix now forms part of Sibanye Gold.
Mondi focuses on improving energy efficiency, increasing energy generation through combined heat and power technology and increasing the use of biofuels. Since 2004, it has increased its use of renewable energy from 47% to 57%, with plans to use more renewable raw materials such as biomass. Mondi already has a CDM-registered biomass project in Richards Bay, KwaZulu-Natal.
These examples serve to demonstrate that there are mining companies in South Africa that take the implications of climate change sufficiently seriously. It is in the best interests of the companies, their investors and the country that they continue to do so.
How important is green investing really?
This question addresses two interrelated angles. The first is the role of investors as allocators of capital. If investors fail to invest in a sustainable way, the economy has a high risk of developing in the wrong direction. If this happened, we would be unable to respond to the challenges facing us. So, this first point is about why it is important to society as a whole.
The second angle is investors’ responsibility to themselves. The question of climate change presents the world with an external/environmental threat on an unprecedented scale — in terms of geographic effect, time scale, complexity and the effect on human life. Companies that choose to ignore this will put themselves and their investors in a precarious position. As extreme climate events become more frequent, companies require resilience to withstand them.
Resilience is a key term in the literature around climate change and can refer to nations, ecosystems and companies. Basically, it refers to the ability to withstand multiple shocks in quick succession. Companies that have not planned for climate change could put their profits and their very existence at risk.
But this does not mean that companies with good carbon management credentials do not still "offend". Most companies, even those in the Carbon Disclosure Leadership index, still emit greenhouse gases. Rather, it is about carbon management. The leaders are reducing their emissions and taking action to prepare their companies for climate change (mitigating and adapting). If something goes wrong in surrounding environmental issues, they are far more likely to take it seriously and manage it with less damage than a non-leader.
An international research paper, The Relevance to Investors of Greenhouse Gas Emissions Disclosures", by P Griffin (University of California, Davis), D Lont (University of Otago) and Y Sun (University of California, Berkeley), poses this important question: "Do stock investors view climate-change disclosures by companies as relevant for valuation purposes, where investor relevance means that the disclosures relate to a reassessment by investors of stock price conditional on the total mix of information available?"
The key findings from this report are:
• There is a negative relationship between greenhouse gas emissions and the relative valuation of a company’s stock price — the more the emissions, the lower the stock price.
• The relationship is stronger for carbon-intensive companies.
• Companies that choose not to disclose are similarly affected based on predicted emissions using comparative, disclosed CDP data.
This report confirms that the extent to which a company focuses on sustainable business practices that translate into an improved financial bottom line drives investment valuations, and ultimately relative investment performance.
The South African experience is well illustrated through the performance of the Nedbank Green Index — since mid-2008 (its inception date) it has outperformed the JSE all share index by more than 3% a year on average.
Although there have been periods of short-term underperformance, the premise of sustainable investment is for the long term. This is the alpha that has been termed "the green premium" in investment.
• Visser is head of beta and ETFs, global markets, at Nedbank Capital.