Leon Greyling, Chairman: Motswedi Investment Committee
As a “retired” investment consultant advising institutional investors on multi-manager portfolios, I’ve witnessed a profound shift in how we assess asset managers. No longer is the focus solely on financial metrics like alpha generation or Sharpe ratios; or let’s face it…whose presentation is best! Instead, Environmental, Social, and Governance (ESG) principles offer us a great guide for a rigorous due diligence. ESG integration not only reveals how well-briefed asset managers are on their portfolio companies but also fosters substantive dialogues during evaluations. Moreover, aligning ESG with sustainable business practices – drawing from frameworks like those in Harvard Business School’s (HBS) Sustainable Business Strategy course – ensures that portfolio companies operate in ways that sustain long-term growth and opportunities. In this article, I’ll explore these dimensions, emphasising why ESG is indispensable for forward-thinking investors.
First, consider how ESG principles enhance an asset manager’s stock research process, ensuring they are thoroughly briefed on portfolio companies. Traditional stock analysis might delve into balance sheets, earnings forecasts, and competitive positioning, but ESG adds layers of insight into non-financial risks and opportunities that can materially impact performance. For instance, environmental factors like carbon emissions or water usage can signal regulatory risks or innovation potential in a company’s operations. Social aspects, such as labour practices or community engagement, highlight human capital management and reputational vulnerabilities. Governance elements, including board diversity and executive compensation, uncover potential agency issues or ethical lapses.
In my experience advising on multi-manager strategies, asset managers who embed ESG into their research demonstrate a deeper understanding of their holdings. They don’t just know the numbers; they comprehend the broader ecosystem. Take a tech firm in a portfolio: a manager well-versed in ESG might analyse how the company’s data privacy policies (governance) mitigate cyber risks, or how its supply chain labour standards (social) avoid disruptions from worker strikes. This holistic briefing allows managers to anticipate black swan events, like the 2020s supply chain crises exacerbated by poor ESG oversight. As an investor, we prioritize managers who use ESG data from sources like MSCI or Sustainalytics to score companies, ensuring their research isn’t superficial but predictive of long-term value creation.
This enhanced briefing naturally leads to more substantive conversations during due diligence on asset managers. When we conduct manager reviews for clients, ESG serves as a litmus test for intellectual rigour and alignment with our values. Rather than stale questions about past returns, we dive into how ESG informs investment theses. For example, we might ask: “How did ESG analysis influence your decision to hold or exit a position in an energy stock amid the transition to renewables?” A well-prepared manager can articulate specific ESG metrics – say, a company’s Scope 3 emissions trajectory – and link them to financial outcomes, sparking a dialogue of substance.
These discussions reveal the manager’s process integrity. In another example, an asset manager showcased how social factors like employee diversity correlated with innovation metrics in their biotech holdings. This wasn’t fluff; it was backed by proprietary ESG models that predicted revenue growth. Such exchanges build trust, allowing us to probe deeper into risk management and alignment with client mandates. Without ESG, due diligence risks becoming transactional; with it, it evolves into a collaborative exploration of sustainable alpha. As an investment consultant/multi-manager, we’ve seen how these conversations differentiate top-tier firms, fostering partnerships that endure market cycles.
Central to this is how ESG principles align with sustainable business practices, as outlined in the HBS Sustainable Business Strategy course. The course emphasises purpose-driven strategies that drive systemic change, ensuring companies not only profit but also contribute to societal well-being. Specifically, it highlights five key elements for building a sustainable business by giving equivalent focus to each: serving your customer, serving your shareholders, serving your employees, serving your regulator (good governance), and serving your community. By balancing these, businesses create long-term sustainability as each element feeds the other. ESG principles directly support this multi-stakeholder approach:
- Serving your customer: ESG encourages asset managers to invest in companies that prioritise customer well-being, such as through ethical product sourcing or data protection, aligning with social and governance factors to build loyalty and sustain market share.
- Serving your shareholders: Through ESG, managers focus on long-term value creation, mitigating risks like environmental liabilities that could erode returns, ensuring shareholders benefit from resilient, profitable operations.
- Serving your employees: Social ESG elements promote fair labour practices, diversity, and employee development, fostering a motivated workforce that drives innovation and productivity for enduring growth.
- Serving your regulator (good governance): Governance in ESG ensures compliance, transparency, and ethical leadership, building trust with regulators and avoiding penalties, which sustains operational freedom.
- Serving your community: Environmental and social ESG criteria guide investments toward companies that minimise harm and contribute positively to communities, such as through sustainable resource use or philanthropy, access to education and services, creating a supportive ecosystem for future expansion.
These elements, rooted in the course’s framework, illustrate how balanced stakeholder service can catalyse industry-wide shifts. The course preaches that equivalent attention to all five reinforces sustainability, where shared value among stakeholders creates a virtuous cycle. ESG equips asset managers to evaluate if portfolio companies adhere to this balance, ensuring they act responsibly, and establish an environment for long-term sustainability of earnings/returns.
Ultimately, by aligning ESG with these practices, portfolio companies sustain opportunities and a conducive environment for future growth. Unsustainable actions – like environmental degradation or social inequities – erode value over time, as seen in scandals like Volkswagen’s emissions fraud or labour issues at fast fashion giants. Conversely, ESG-aligned firms mitigate risks, capitalise on trends like net-zero transitions, and build resilience. For investors, this means portfolios that not only deliver returns but also contribute to a stable global economy.
In conclusion, as advisors navigating complex markets, we view ESG principles as a vital tool for assessing asset managers’ preparedness, enabling meaningful due diligence, and ensuring alignment with sustainable business practices. By integrating ESG principles, we safeguard future growth, turning investments into forces for positive change. With global challenges mounting, from climate shifts to inequality, embracing ESG isn’t optional – it’s a guide for enduring success.
ENDS
