This column was first published in Business Day.
As soon as the border is open, I plan to have a long holiday in some of my favourite spots in SA’s nine provinces. Maybe I will check out what the fuss is about in Nkandla. I know where I want to go, what I want to do and when, how much it will cost — and who is responsible for making it happen.
I am sure we all made plans in lockdown we didn’t keep. “Learn Mandarin” comes to mind. The plans were non-specific, uncosted, amorphous, too big to handle and involved slipped schedules.
Does President Cyril Ramaphosa know how to plan?
This is a very serious question at the heart of the current malaise as SA slips towards the fiscal cliff edge. He has given very little hint that he does — though there are occasional forays of loyalists in the media saying there is a 10-year (two-term) “governance masterclass” arc of a plan, without any real evidence for it. One wonders how easy it is to plan without, for instance, an energy adviser in one’s office.
Businesses know they live or die by their ability to plan supply off forecast demand, to plan workforces and investment. A fascinating cycle of board meetings occurs annually, particularly in about September and October, in which the biggest companies discuss and sign off on the following year’s budgets, investment decisions and levels of risk appetite.
These types of meetings for 2021 are about to start. What will they say? Does the government even know that decisions that will dictate 2021 are already being made, while load-shedding and political navelgazing are ongoing?
The government has generally been exceptionally poor at planning.
The National Planning Commission does less planning than broad strategic direction research — excellent though it is, particularly recent papers on state-owned enterprises (SOEs) and the digital future (which are well worth reading). The failure of the National Development Plant (NDP) was to not shift it from the good initial plan into a timelined and budgeted work plan.
Government plans lack specificity, and with it the ability to hold ministers and directors-general to account.
There have been rare exceptions. Former finance minister Malusi Gigaba’s 14-point plan in 2017 was unique in laying out a specific timeline for implementation, though it was quickly abandoned.
Similarly, the Eskom road map by public enterprises minister Pravin Gordhan lays out actual goals with dated timelines. These have allowed the energy industry to hold Eskom to account recently for pushing back and then dragging forward, under pressure, dates for its unbundling to take place.
Ramaphosa’s 10-point plan for the economy in 2018 has been long forgotten because there was no detail, costing, timelines or delineated responsibilities. These are the key conditions.
Plans ultimately gain credibility and buy-in, and are accepted in corporate board planning meetings, only if these key conditions are met. They are not currently met regarding the economy, so markets, companies and investors do not give the government the benefit of the doubt.
It is equally true for corruption. That is why the bar was set so high for the past weekend’s ANC national executive committee meeting. Only if real and solid measures regarding ANC membership (and various issues such as wages and pensions that go with them) are withdrawn will the bar be cleared.
So we turn to discussions among Nedlac social partners about a recovery and reform programme. Is it a recovery plan to sit in a room with big labour, big government, big civil society and big business armed with large Velcro words to stick on the wall? If we say “infrastructure”, everyone will clap in agreement and can “compact” that this is all a jolly good idea. But so what?
What is the mindset on the issue of state versus private enterprise? What is the specificity of who will do what within the government, in business, development banks, banks and asset managers? What are the specific funding, tendering and project design modalities?
All these questions won’t generate much bonhomie but are challenging and might require challenging decisions and the expenditure of political capital to break through. The “agreement” — much trumpeted in the media — between social partners on “plans” has been a chimera.
If there is no specificity, costing, timelines or delineated responsibilities, the process will generate much spin and PR but it will flop.
Now is the test for whether Ramaphosa had some type of plan all along. A plan that meets the conditions will raise eyebrows and give him the benefit of the doubt as political capital will be seen to be deployed. Interest rates will fall and capital will flow.
A well-made plan will cause skills and capacity to be deployed across sectors (yes, some real Thuma Mina).
(The capacity issue is there but is for consideration on another day.)
Everyone is tired of plans because real ones are so rare. That can be changed, but it won’t be easy. Momentum, or the lack of it, will be key after the weekend, combined with the right people (such as a new energy minister) and real leadership — all to help the economy not just recover to its previous, slightly slower, grind towards real crisis but to properly diverge to somewhere new and exciting.
• Attard Montalto is head of capital markets research at Intellidex.
Banks taking an extra conservative approach to impairments are finding market support, says Intellidex’s Stuart Theobald. Featured in Reuters.
Corruption is so deeply rooted within the ANC and how it manages political power that it is impossible to change without party-wide reform, says Intellidex analyst Peter Attard Montalto in response to President Ramaphosa’s letter to his party. Featured in Business Tech.
This column was first published in Business Day.
We are increasingly in love with the idea that investments can do good and not just deliver a financial return. Pressure has been growing worldwide for investment managers to consider the social impact of investments alongside risk and return. In SA, regulation 28 of the Pension Funds Act requires pension fund managers to think about the trifecta of environmental, social and governance (ESG) issues when making investment decisions. A guidance note in 2019 from the Financial Sector Conduct Authority said funds should put ESG criteria into their investment policy statements and make these available to members.
Recent research by my firm Intellidex found that almost all pension fund principal officers are expecting sustainable investing to become more important over the next five years, and some even think it is more important than generating returns.
This direction of travel appears to be positive, but I’m sceptical about the conceptual starting point. If we can use investments to make the world a better place and not only deliver a financial return, that seems an obviously good thing. Many argue that sustainable investing can deliver better financial returns anyway. This argument is convenient in that it helps remove tension between those who benefit from the financial returns of an investment and the social returns. Seldom are these the same people.
But I doubt that we can magically get both financial returns and ESG. It seems on purely logical grounds unlikely that ESG investments will match or outperform non-ESG investments for several reasons. One is that as the popularity of ESG investing grows, demand increases for compliant investments, increasing their price and therefore reducing potential returns. Another is that an ESG investing strategy is about constraints — avoiding investments that don’t fit set criteria.
A fund that is constrained has a narrower investment option set by definition. An unconstrained fund can mimic the strategy of the constrained one, but always have the freedom to deviate when tactical opportunities come its way. It seems illogical to say that the constrained fund can outperform the unconstrained one.
The argument against this seems to be that investments that meet ESG standards overcome companies’ natural tendencies to focus on short-term profits that cause longer-term problems. There may be something to this. Bonuses and other performance incentives must be specified in easily measurable terms and fit the normal remuneration cycle. Reward systems are much easier to use for short-term financial targets than objectives of 10 to 20 years with hard-to-measure outcomes like better relations with the local community.
Companies take higher risks and ignore long-term costs, resulting in rewards to managers but pain to shareholders when risks don’t pay off and long-term costs come to bite. So, by pushing a set of ESG objectives onto company managements, one overcomes the problems of short-term incentives leading to companies that create greater long-term value for shareholders.
This seems to be the argument that influential fund managers such as BlackRock advance in saying its “investment conviction is that sustainability-integrated portfolios can provide better risk-adjusted returns to investors”.
I can buy that ESG forces a greater alignment between managers and shareholders, but that is not meant to be the point of ESG. If ESG is just a management-discipline tool then we should call it that. But ESG is meant to be about stakeholder capitalism, ensuring that all interests of those affected by companies are considered. And it cannot be that shareholders are always going to be aligned with other stakeholders, unless there is some radical redefinition of what shareholders’ interests actually are.
If shareholders genuinely desire positive social outcomes, and not just good risk-adjusted returns, then there may well be the possibility of alignment. Shareholders’ return set would now consist of both financial and social returns. But if they value the social returns, they should be willing to give up some financial return in an effort to maximise both. We would then see the market reflecting these views, with prices rising for ESG investments, reducing yield on such funds. Again, it would be the case that financial returns were being sacrificed to achieve positive ESG outcomes.
Some impact investments make this explicitly clear. You can right now go and put your money into Kiva microloans, a nonprofit crowdfunding mechanism that provides loans to individual borrowers in emerging markets. You would get no interest on your loan, but the idea is to get your capital back and to help an identified individual (for example, you can chose a vulnerable refugee) whose progress you can track. Their success is the social return you get for sacrificing the financial return of interest you could have earned on your money.
When it comes to companies applying ESG criteria, I think it is important that companies are clear about where they are willing to give up financial returns if it has a big social impact. Banks, for instance, should be clear about reallocating capital to lending that might reduce yield but increase impact. That should be measured and communicated to stakeholders.
Institutional investors need to think through their mandates and alignment with their clients’ views on social impact. It is no longer acceptable to declare that fiduciary responsibility requires that risk and return be all that matters. We need to take social return seriously, gauging our clients desire for it, and then using it in decision making. We need to be honest that ESG strategies are not only about maximising financial return.
Theobald is chair at Intellidex.
This is one of a series of columns that were produced for Moneyweb Investor in which Stuart Theobald explores the intersection of philosophy of science and finance. This followed an earlier series for Business Day Investors Monthly on the same theme. May 2016.
The American economist Paul Krugman recently coined a useful phrase: “the politics of epistemology”. He was writing about the way American politics has distorted what it means to claim something is true. The primaries process has seen all sorts of bizarre claims from all sides. It struck me as a good way to make sense of South African politics right now.
Philosophers talk about epistemology as the as the study of what we know. It is contrasted with ontology, which is the study of what there really is. Ever since Descartes and Berkeley, we’ve been worried about whether what is inside our heads is at all related to what is actually in the world. That remains the case. For example, one live debate in the philosophy of science is whether a concept like a “quark”, and abstract entity proposed by theoretical physics but which we have never observed, is purely an epistemic concept or whether it is something that actually exists in the world – an ontological fact. It may be that theories in physics use concepts that are instrumentally useful like quarks and strings, because they allow for good predictions, but that don’t actually exist in the world.
The politics of epistemology concerns how political power can weigh in on what we see as true or false. So some in South Africa apparently believe a respected, high-achieving finance minister can have committed espionage (a crime which doesn’t actually exist under South African law), while a president who faces 783 counts of fraud and corruption has done nothing wrong. No one seems to care about what is actually true, but rather with what is politically useful to think is true. So we can all think president Zuma never said he wouldn’t pay back the money. Where your political colours are nailed determines what you think the facts are, and what you want others to think the facts are, and reality doesn’t matter. Sadly, some in the media are useful instruments in this effort at fact-making, faithfully reprinting unquestioned what they are fed, and then helping to make other people think they are true.
What has all this got to do with investing? Two things. First it helps to understand that in the political process, the facts don’t always matter. Second it helps to not be distracted and remember that it is the ontology of our economy that really matters to investment performance.
Making up facts works only to a point. The judicial system provides a line in the sand, a point at which epistemology has to meet ontology. Partly this stems from the political strategy of claiming things are contingently true up until a court rules. This is double edged sword for the erstwhile political epistemologist. It allows them to straight-facedly claim something is the case – say that Pravin Gordhan should be investigated – because ultimately it is a court that will decide whether he did anything wrong. That buys them space to spread the belief that he did wrong as part of a wider effort to discredit him, assisted by using the investigating resources of the state to intimidate him and add credibility to their efforts. But then, when a court does rule against them, a rapid damage control exercise has to be launched. So in the long run, as long as our judiciary remains independent, reality does matter.
But for investors, cold hard reality is what matters all of the time. South Africa’s unemployment rate has never been higher. Our economy will grow only half a percent this year, meaning we are poorer per head than we were last year, and significantly poorer in dollar terms. That has serious political implications – with everyone, on average, getting poorer, many social ills that were being tolerated suddenly won’t be.
But, on the other hand, the slight uptick in resources prices is shifting the economics of production for a large part of our economy. The tough recent times faced by mining companies have forced them to dramatically improve their efficiencies. They are now positioned for a sharp upswing in performance. The sharply weaker rand, helped down by the reality of our political dysfunction, has a strong stimulatory effect on some substantial parts of our economy, including what’s left of our manufacturing base. Despite a dramatic skills constraint, our services sector is also in rude health and can improve its own export capability.
The ratings agencies are keenly watching these facts. They are focused on whether South Africa will meet its debt obligations. That depends on the willingness to do so, and on the ability to do so. The first depends on our politicians while the second depends on our economic performance. So far, government has managed to convince the world that we have every intention of maintaining a sound fiscal stance and continuing to keep our debt serviced and under control. Moodys this month said it thinks economic performance will pick up next year. It well might, and the true facts are what we need to keep focused on to be able to tell. So despite the politics of epistemology, you are best served by keeping an eye on the numbers. And those are not all negative.
With SA at the jaws of the hippo, failure to fix our problems means that the IMF will shut the hippo’s jaws for us, says Intellidex’s Peter Attard Montalto. Featured in Daily Maverick.
SA’s economic response has been haphazard, late and frankly poorly thought-out, says Intellidex’s head of capital markets research, Peter Attard Montalto. Featured in Bloomberg Quint.
We expect a very sluggish recovery from the Covid-19 crisis. National Treasury’s stimulus package will run its course, but unemployment will rise and credit conditions tighten. Intellidex is featured in Business Tech.
This is one of a series of columns that were produced for Moneyweb Investor in which Stuart Theobald explores the intersection of philosophy of science and finance. This followed an earlier series for Business Day Investors Monthly on the same theme. This column was first published in March 2017.
Is doing good profitable? Are companies that prioritise having a positive social impact also ones that make the biggest returns for investors? It would be very comforting if the answer was “yes”. It would mean that the decision over what to invest in can be made both by thinking about which companies are good for society and which companies are good for their financial returns. We wouldn’t have to choose one or the other. Unfortunately, it’s not that easy.
There are many technical developments that have supported investors in accessing socially responsible investments (SRIs). The JSE operates a “Responsible Investment Index Series” with Top 30 and general indices that include companies that meet the JSE’s responsible investment “ground rules”. They were introduced in 2015 to replace the JSE’s previous SRI index that used a different methodology. The exchange-traded fund market has also various options that allow investors to choose investments that meet certain social objectives, such as Absa Capital’s “NewSA” ETF or Grindrod’s CoreShares “Green” ETF. Oddly, there is not currently an ETF based on the JSE’s responsible investment index. Perhaps that is because support for the ETFs have been minimal, with the NewSA commanding assets of R36.7m and the Green ETF R45.7m. To put that into context, the Satrix 40 ETF has assets of R6.7bn.
There is no doubt, however, that social investing is a growing trend. According to a US-based study, socially responsible investments now account for 20% of global capital markets, with $30-trillion of assets based on SRI principles. A lot depends, however, on how SRIs are determined. I imagined that the important issues are sustainability, so wouldn’t expect mining companies among constituents, or avoiding socially harmful products, so wouldn’t expect cigarette companies. Yet in the JSE’s SRI Top 30, you’ll find both Anglo American, together with its platinum and iron ore subsidiaries, and British American Tobacco. The index is assembled by FTSE Russell, created by rating companies on environmental, social and governance measures (ESG), ranging from support for biodiversity and respect for human rights, to anti-corruption procedures. A company which does little for the health of its customers, can score on various other measures such that it makes the grade. It should be clear, however, that when comparing SRI-based investments to non-SRI investments, there might not actually be much difference beyond the application of the label “SRI”.
The argument that social returns and financial returns are congruent usually works by claiming that socially responsible companies have better relationships with their stakeholders. As a result, customers are more loyal, staff more content, and regulators and politicians more conducive to supporting a positive environment in which that company can profit. They are also more sustainable, so don’t exhaust the resources necessary to maintain profitability. Such arguments put profitability as the prime objective, essentially claiming that social responsibility is good because it’s profitable, and not because it is good in its own right.
The evidence is ambiguous. There have been many studies globally that compare SRI funds with general funds, usually finding that there hasn’t been much difference (though there are exceptions which have found SRIs outperform). This is largely because there’s not actually much difference in the underlying companies held in SRI and non-SRI portfolios. One study applied a higher bar to see what would happen to performance. It considered three different ESG ratings providers (not FTSE Russell used by the JSE, but similar) and portfolios of high rated companies with low rated ones in the US. So this eliminates the overlap between ESG and non-ESG, effectively dividing the universe into two separate halves (or smaller fractions by pushing up the cut off for the high group, and down the cut-off for the low group). Even then, the study found that there was no material difference between the high and low rated portfolios, and that it would be impossible to create a sustainably outperforming investment strategy as a result. This did differ depending on the particular ESG rating system that was used, however, so there may be an argument that ESG outperforms, provided only that the right ESG measure is used. This ambiguity can be seen in the JSE’s indices too – the old SRI index underperformed the Top 40 index in the three years to the switch in 2015, since when the new SRI index has slightly outperformed.
The impact on profitability of ESG factors is at least partly a function of policy. If governments introduce carbon taxes, for example, carbon intensive industries are going to become less profitable. So the performance of high-ESG scoring companies may be the result of administrative fiat rather than normal market forces. This works the other way around too – promises by president Donald Trump that he will slash environmental and other regulations on American business have caused a share price rally, as lower ESG-scoring companies look set to benefit.
Even if we accept that SRI investments don’t consistently outperform non-SRI investments, it also follows that they don’t underperform them. If we accept that investing is not only about profit, the lesson we can take away from that is that SRI investing does not come at a cost. That is still true when more stringent ESG criteria are applied. That alone suggests SRI investing is at least as good as non-SRI investing, and probably better for other reasons.
However, even on future profitability, it seems hard to resist that as climate change forces environmental concerns up the agenda, and the growing middle class in emerging markets demand increased health interventions, policy is going to systematically favour higher ESG scoring companies. Trump may be a very short term bump in the road toward that outcome. SRI investing comes at no cost, and is effectively an option on the upside that regulation may induce. The trick, however, will be to figure out just which companies are going to thrive in such an environment, and standard SRI measures may well fail to capture it. There may be no short cut other than examining companies case by case and exercising judgement about their sustainability in an environment of ever-strengthening ESG regulation.
 Gerhard Halbritter and Gregor Dorfleitner. 2015. The wages of social responsibility — where are they? A critical review of ESG investing. Review of Financial Economics. Volume 26, September 2015, Pages 25–35.
This is one of a series of columns that were produced for Moneyweb Investor in which Stuart Theobald explores the intersection of philosophy of science and finance. This followed an earlier series for Business Day Investors Monthly on the same theme. This column was first published in March 2016.
Just what is economics and how does it work? Pretty much everyone who studies a commercial degree in South Africa has to do some economics along the way. Many arts students pick it up too. Often they take just enough to get a rough idea of some big ideas in economics – demand and supply, micro and macro. Those certainly provide useful insights into the way economies work, but how?
Just about everything presented in those elementary courses comes in the form of “models”. Here are a few that may jog your memory: the “model” of demand and supply, with downward sloping demand curves and upward sloping supply curves, showing that higher prices induce greater production while lower prices induce more purchasing until they find an equilibrium. The IS/LM model shows how interest rates and money supply affect aggregate output, a graphical representation of Keynes’ general theory. The older Ricardian model of international trade, illustrates how countries that trade benefit because of “comparative advantage” even if one country is more efficient in every respect than another. Then there is the Lewis model of development showing how urbanisation draws labour from the agricultural sector.
All of these models are the basis for lots of debate when it comes to making sense of the world. Some apply quite clearly, illuminating trends we can see in actual economies, while other situations appear to not match at all. But what is notable is that economics uses this method of arguing through models.
Economics is not the only science to reason in this way. Physics also has many models, ranging from the solar system to the “standard model” of particle physics that proposes that the world is ultimately made up of quarks, photons and other elementary particles.
Often models are criticised for being “unrealistic” but that seems to miss something important. Models are useful precisely because they are simplified representations of systems. The social world is messy, even more so than the physical world. Physics models are also simplified, for example, assuming points, vacuums and dimensionless planes, all things that don’t actually exist. Economics does something similar by assuming things like perfect information, zero transaction costs and rational decision makers, all things that don’t really exist either. London’s underground map is an unrealistic model too – it has little resemblance to the actual distance between stations, but provides a good tool to understand how to navigate through the system to get where you want to go.
(Incidentally, some neuroscientists have recently made quite provocative arguments that our cognition of the outside world is really just a model. They are argue that evolution is efficient – it wouldn’t give our brains the ability to comprehend “reality” if an abstract model that required less cognitive machinery would serve just as well in our efforts to survive and procreate. This might be why our brains find it so hard to comprehend some arguments in physics, like the simultaneous wave/particle nature of light and the 10 dimensional space time proposed by superstring theory. Maybe our mind’s model of the world is unrealistic. Luckily it is still useful.)
The Harvard economist Dani Rodrik, who was a key advisor to the South African government during the economic policy debates of the 1990s, has recently published a fascinating book exploring the nature of reasoning with models (called Economics Rules). He argues that economics progresses horizontally by widening its library of models rather than vertically by developing ever more accurate models. That library of models can sometimes flatly contradict each other, but in figuring out which one to apply we learn things about the economy we are studying.
Ever more accurate models of a particular economy would be ever more complex, perhaps as complex as the whole economy itself. But such a model would be quite useless to an economist wanting to understand other economies. The more detailed a model becomes to fit the particular, the less useful it is to understand the general. Simplified models may give us more insight to understand novel situations. And the more models we can draw on to study how they may apply to a situation, the more “truth” we may be able to discover.
When it comes to investing, we rely on economic models to help understand trends in the broader economy, but we have models to understand investment principles too. The “mean variance optimisation” model of the 1950s tells us why we should invest in a diverse portfolio. The Capital Asset Pricing Model of the 1960s tells us we should demand higher returns from riskier assets. But models are only a reasoning tool. We have to still do the hard work of understanding investment opportunities directly. Models can sometimes lead us astray, as the disastrous “value at risk” models did before the financial crisis, which allowed central bankers to think all was ok with the financial system. By understanding just how economics reasons with models, we may be better at avoiding the pitfalls.