Friday 29 Mar 2024
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This article first appeared in Capital, The Edge Malaysia Weekly on July 16, 2018 - July 22, 2018

FROM Enron to Volkswagen’s “Dieselgate”, the corporate world is not short of questionable management practices that have not only caused social justice warriors to occupy Wall Street but also sent a chill down shareholders’ spines as they watched once high-flying counters tumble in a matter of days or weeks.

From 1996 to 2001, Enron was the darling of Wall Street. Its share price soared to US$90.75 in mid-2000 and it was named “America’s Most Innovative Company” by none other than Fortune magazine for six consecutive years.

However, after an accounting and financial scandal erupted at the company, many shareholders found themselves getting the short end of the stick. They and the employees received limited returns through the courts and lost billions in pension money and investment funds.

Malaysia’s corporate world has had its fair share of governance and environmental scandals. Many may still remember the Bumiputra Malaysia Finance Ltd affair, which led to the death of an assistant manager at its subsidiary in Hong Kong.

Then, of course, there is 1Malaysia Development Bhd, which is still under investigation in various jurisdictions, locally and abroad.

Financial and environmental scandals not only affect the reputation of corporations but also cause massive destruction of value. For large investment funds, financial and environmental scandals have to be avoided as best as they can as they are the custodian of funds for millions of people.

However, is it possible for companies to implement good environmental, social and governance (ESG) practices and yet generate good returns?

Investing based on the principles of good ESG practices can provide higher-than-average returns for investment funds, says Ismail Zakaria, director of the Corporate Strategy and Performance Department at Kumpulan Wang Persaraan (Diperbadankan), or KWAP.

What is most important for KWAP, as the custodian of pension money for millions of public-sector workers, is that it can ensure sustainable, long-term returns.

“ESG is very much directly related to sustainability and, as a pension fund, we are in the long-term business. There is a possibility that our pensioners may live longer in retirement than during the length of time they worked.

“Hence, we would want our investee companies to maintain a certain level of performance, not just in the short term, but over the long term because our performance as a pension fund is highly dependent on that,” Ismail says in an exclusive interview with The Edge.

Since its inception in 2007, KWAP has been able to generate an average gross return on invest­ment (ROI) of 6.14%. Last year, KWAP’s gross ROI was 5.77%. The pension fund had an asset size of RM140.8 billion as at end-2017.

Globally, ESG-sensitive assets have grown tremendously to hit US$81.7 trillion as at end-April this year, represented by the 1,961 investment funds that are signatories to the United Nations-supported Principles for Responsible Investment (PRI).

In February, KWAP and Khazanah Nasional Bhd became signatories to the PRI.

KWAP started its journey in good ESG investment decision-making practices in 2011. In 2014, it set up a dedicated unit called Responsible Investment under its Corporate Strategy and Performance Department, which Ismail is currently heading.

This unit is tasked with coming up with ESG investment guidelines for all its investment units. It also acts as KWAP’s representative when it comes to engaging with its investee companies in the corporate responsibility spectrum.

At the same time, KWAP also created a responsible investment mandate within its Equity Investment Department. This mandate, which started with an asset size of RM500 million, grew to RM3.8 billion last year.

While this mandate made up only 2.7% of KWAP’s total fund size of RM140.8 billion as at Dec 31, 2017, the establishment of the Responsible Investment unit has had an impact on the pension fund’s investee companies. For example, the unit engages with the investee companies, observes their ESG practices and makes recommendations on how they can improve further. The companies are then given a stipulated time to achieve the improvements.

“ESG assessment is a risk mitigation tool that we adopt to avoid reputational and financial risks. The recent corporate scandals that hit Toshiba and Volkswagen show that a lot of the time, companies, in their aim to give good returns, overlook or find ways to get around ESG considerations,” says Rizal Mohamed Ali, vice-president of responsible investment at KWAP.

“So, for us, as an institutional investor, while we are mindful of generating good returns, we do not want our investments to be tainted by any corporate scandals. We feel that if we adopt good ESG practices, we can avoid risky investments and it provides red-flag mechanisms to detect governance issues,” he says.

KWAP also engages with the top management of the investee companies on their proposed resolutions at general meetings, says Ismail. ESG plays a vital part in these discussions.

However, KWAP does not undertake negative screening of industries that have drawn negative publicity, or whose image has been affected due to the nature of their businesses. Instead, it engages with the companies and looks at ways to improve their business processes, says Rizal.

This is because KWAP is responsible for supporting not only the government’s pension liabilities but also — as a major government-linked investment company — the growth of the national economy and local industries, he adds.

So, how has KWAP’s responsible investment mandate turned out? Has it been able to deliver higher-than-average returns? After all, KWAP has a huge burden to take over the RM300 billion in pension liabilities from the government.

“Those are equity mandates, where we need a longer period to be able to share in a meaningful way the impact of the ESG investment style,” says Ismail.

“But we believe, based on the literature and research done by many experts around the globe, those investment mandates that embrace ESG factors and integrate them into their investment decision-making process will be able to generate above-average returns in the longer term.”

One can look at the performance of the MSCI AC Europe ESG Leaders Index and the MSCI Emerging Markets ESG Leaders Index to see whether investing in ESG-sensitive stocks pays.

Over the last five years to June 29, the MSCI AC Europe ESG Leaders Index had an annualised gross return of 8.95%, compared with 8.78% by the MSCI AC Europe Index. The former also outshone the latter over a 10-year period, with gross return of 6.77% versus 5.72%.

As for the MSCI Emerging Markets ESG Leaders Index, it saw a gross annualised return of 7.84% over the last five years to June 29, compared with 5.39% for the MSCI Emerging Markets Index.

The MSCI Emerging Markets ESG Leaders Index, meanwhile, posted a gross annualised return of 7.09% over a 10-year period, compared with the non-ESG index’s 2.6%. 
 

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