The development of socially responsible investment in South Africa: experience and evolution of SRI in global markets

Abstract

Sustainability practices, particularly those relating to Socially Responsible Investment (SRI), have still to be fully evolved in a developing country context. This article considers international trends in SRI and how these may relate to South Africa. It considers how, internationally, SRI has become increasingly motivated by the business case for risk-management and therefore how it may have the potential to offer superior returns (as demonstrated by recent experience in the United States). It examines the relevance of SRI trends to South Africa, where the concept of SRI still faces further structural development, and reviews the performance of funds operating in the South African SRI arena.

1. Introduction

The World Summit on Sustainable Development (WSSD) hosted in Johannesburg in September 2002 raised a number of seemingly ambitious issues; chief among these, that of sustainability and how commercial activity can embrace a long-term perspective and non-financial objectives in the interests of ‘people, planet and prosperity’. As Sen (2004) argues, this concept is profound: ‘The question can… be asked whether environmental priorities should be seen in terms of also sustaining our freedoms. Should we not be concerned with preserving – and when possible expanding – the substantive freedoms of today “without compromising the ability of future generations” to have similar, or more, freedoms?’

These debates and issues surrounding the concept of sustainability, however, evolved largely in the context of experiences in the northern hemisphere, although developments such as specific consideration of dynamics, for example reporting on HIV/AIDS by the Global Reporting Initiative (GRI), are beginning to suggest progress in widening its relevance for the southern hemisphere. Nevertheless, despite the urgent necessity for developing countries to ensure that their growth is not compromised by environmentally reckless actions or, on the other hand, restrictive agreements (banning DDT that is needed to fight malaria, for instance), sustainability benchmarks tend to apply to and focus on mainly developed countries.

To date, socially responsible investment (SRI) – defined in this article as investments that promote social as well as financial objectives – reflects this developed country bias too, but there are some interesting movements and issues in South Africa that suggest there is room for its growth in other regions. It should be noted that the important areas of corporate social investment and responsibility exercises are beyond the scope of this definition of SRI, but are relevant in the context of non-financial reporting initiatives, especially where investors screen companies as suitable vehicles for SRI, often as components of stock exchange indices. This article considers SRI trends based on the history and evolution of SRI internationally to determine where their relevance lies in South Africa.

2. The context and history of SRI

Ironically, perhaps, South Africa was a major driver of international and, in particular, US SRI (which accounts for the greatest share of funds invested with a socially responsible mandate). Although the roots of SRI extend back to the Quakers' avoidance of investments in gambling and alcohol (or what is now termed ‘negative’ screening) and was bolstered by the 1960s peace and green movements, it was the avoidance of South African companies that propelled SRI into the mainstream investment arena. South African companies that were shunned included those that failed to subscribe to the Sullivan principles. The Global Sullivan Principles were drafted in 1985 for companies doing business in apartheid South Africa under the leadership of Reverend L Sullivan. Companies endorsing these principles undertake to:

	respect human rights and freedom of association
	promote equal opportunity
	compensate employees to meet basic needs and provide opportunities to improve skills and capability in order to raise employees' social and economic opportunities
	provide a safe and healthy workplace; protect human health and the environment and promote sustainable development
	promote fair competition, including respect for intellectual and other property rights, and refuse to offer or accept bribes
	work with governments and communities in which business is conducted to improve the quality of life of communities and provide training and opportunities for workers from disadvantaged backgrounds; and
	encourage those with whom business is conducted to promote the Principles.

The Principles are to be adhered to consistently in company policies, procedures, training and internal reporting structures, with transparency in implementation.

Church groups, large US municipal pension funds and private investors increasingly voiced their concern that their savings should not support that which they opposed on ethical grounds. Today their moral objections are primarily to gambling, tobacco, alcohol and weapons, as well as environmental degradation and animal and human and labour rights abuses, wherever these can be avoided or mitigated. Figure 1 shows the most commonly screened issues in US funds.

Figure 1: Screening US SRI by area

The relevance of SRI needs to be seen in the context of greater checks and balances against corporate enterprises. Stakeholder interrogation of multinational corporations' conduct has increased as industrial production has become globalised and corporations' economic size has overtaken that of the host economies. (In 1999, the assets of the world's 10 largest banks were equivalent to the value of the combined Gross National Product of all 108 developing countries – IMF, UNEP & World Bank, 2002.) Global media networks and the Internet have allowed for productive activity to be increasingly scrutinised and exposed, for example numerous websites have opposed oil exploration activities in Nigeria. By applying pressure of this kind, previously peripheral drivers for ethical behaviour in the form of socially responsible investors have supported the business case for companies to address issues of sustainability, especially in cases there is a legislated requirement to address non-financial concerns.

The past few years have seen increased legislative pressure in European countries. Disclosure on non-financial (environmental and social) performance – the so-called triple bottom line – is now required of all listed companies in France, for instance, and in the UK pension fund trustees are required to disclose on what basis and how they considered non-financial issues in their investment decision. There are also strong non-legislated incentives. Mainstream funds such as Calpers (the California Public Employees Retirement System – the largest in the US, with $166,3 billion in assets as of August 2004) have demonstrated the significance of non-financial investment priorities by pulling out of well-performing financial investments. Calpers pulled out from countries such as Malaysia and Indonesia, which failed human rights tests in 2001, surprising financial analysts who saw these two countries as the best regional performers (in financial terms).

The Calpers experience is not unique. More than one dollar out of every nine (equivalent to $2,16 trillion) of US pension funds, mutual funds, foundations, religious organisations and community development financial institutions – some 11,3 per cent of investment assets under professional management – is managed by major institutions using SRI techniques (US Social Investment Forum, 2003–04). In the United Kingdon, £3.7 billion is invested in ethical funds, representing about 10 per cent of the UK stock market (ABI, 2001). The world's largest pension fund (for Dutch public employees), ABP, which has $175 billion under management, launched two SRI funds in 2003 (one worth $100 million for US equities and another worth €100 million for European equities) to explore the performance of SRI (Bayon, 2001).

3. The impact of SRI and stakeholder pressure on management practices

With considerable allocations to SRI, its scope is increasingly shifting from the domain of a small group of activists and NGOs to a mainstream risk management issue. Failure to manage non-financial risk can have far-reaching bottom-line consequences which, in turn, limit access to finance and have the potential to destroy shareholder value.

A widely quoted McKinsey opinion survey (conducted in 2000) found that investors are willing to pay a premium for companies that are well governed. The reason for such financial favour, apart from the fact that ‘caring’ employers attract talented staff, is that scandals are a potential liability and can affect reputation and brand value. The consulting group Claros estimated that Exxon–Mobil's stance on human-induced climate change (or, rather, its failure to take a stance) could cost the company $2–3 billion in damages to reputation, $10 million in missed business opportunities and up to $100 million in potential litigation (Hanks, 2002).

Growing numbers of companies across the mainly developed world are reporting on sustainability (as measured by an international KPMG survey), indicating the way international businesses are beginning to identify non-financial risks (KPMG, 2002). The uptake of non-financial reporting is reflected not only in the number of companies (including those with separate environmental reports) and the range of countries participating in the survey, but also in the response rate as an indication of commitment to the area (see Figures 2–4).

Figure 2: Corporate non-financial reporting – companies

Figure 3: Corporate non-financial reporting – response rate

Figure 4: Corporate non-financial reporting – countries in survey

It is symptomatic of the business case for socially responsible behaviour that organisations such as the Association of British Insurers (ABI) have issued seminal guidelines on social responsibility disclosure. SRI, particularly through shareholder activism, has essentially added a new layer to risk management which may shape the future of management practices.

4. Application to South Africa

The application of SRI trends to South Africa hinges on whether SRI is a concept that is affordable or sufficiently flexible for South African pension funds, many of which face restructuring and member losses (demanding liquidity of investment). These limitations to SRI are compounded by investment conservatism prompted by revised legislation that emphasises trustees' fiduciary responsibilities, combined with an inability on the part of investment managers to develop the necessary skills to appraise development-orientated investments (personal communication, Lisa Christodoulou, Social Impact Specialist, Futuregrowth, 2003).

At the same time, guidelines on corporate governance as contained in the Institute of Directors' second King Report on Corporate Governance (King II), are argued to be some of the most advanced in the world (IMF, UNEP & WORLD BANK, 2002). The extent to which guidelines will be applied is yet to be fully demonstrated, however, especially with regard to non-financial reporting. In theory, all listed South African companies should start to issue reports on non-financial performance, but there is yet to be a uniform response to the challenge – at the launch of the JSE's SRIs index, 74 listed companies participated and 51 met the criteria (JSE, 2004). Of those companies that have reported on non-financial indicators, most have significant international operations where non-financial reporting is already a commonplace requirement.

A notable and positive development to support an emphasis on non-financial reporting is the benchmarking opportunity offered by the FTSE (Financial Times Stock Exchange)/JSE SRI index, which was launched in May 2004. This index is the first of its kind in an emerging market and comprises shares of companies that meet the requirement of having integrated the principles of SRI and sustainability into their business practices. Futuregrowth, a leader in SRI asset management, with prominent property investments in areas such as Khayelitsha, recently launched a R30 million equity fund called the Futuregrowth SRI Equity Fund, which is benchmarked against the FTSE/JSE SRI index. This is small in comparison to its other SRI funds, such as the largest fund in the South African SRI sector, the Futuregrowth Infrastructure Bond Fund, which has some R3,2 billion under management (personal communication, Christodoulou, 2003).

Other significant initiatives to channel investments in the interests of constituents include the Community Growth Fund (CGF), which emerged at the end of the 1980s to represent trade union priorities. However, the CGF, and other development funds, represent a small niche area of South African assets under management – analysts estimate the value at less than one per cent (African Institute of Corporate Citizenship, 2002).

Importantly, perhaps, the failure to appreciate the extent of collective ownership, combined with limited shareholder activism by fund managers, lies behind poor levels of activism in channelling funds in the mainstream of South African asset management. This contrasts with countries such as the United States, where capitalism is embraced and where a substantial number of citizens participate in the stock market.

Where South African fund managers have started to become more active in individual investments (such as in the IT company Comparex), it is primarily on the basis of protecting financial value. International experience has, however, suggested that SRI, while not motivated by financial performance, can reinforce it by promoting improved governance.

In the United States, where more than $2.3 trillion is invested in professionally managed portfolios with one or more of three common SRI strategies (namely, screening, shareholder advocacy and/or community investing), the rise in corporate scandals has resulted in further growth in the area. The much-feared bear market, in which SRI might have been viewed as a dispensable luxury, has provided evidence of superior performance by SRI funds, giving the SRI community the authority to lobby on market reforms.

Although market performance has lagged over the past three years, 65 per cent of the 51 screened funds tracked by the US Social Investment Forum earned top ratings from rating agencies Lipper and Morningstar at the end of 2002. Indicative of this success, SRI funds grew in 2002, with net inflows of $1,5 billion, while US mutual funds shrank overall – diversified equity funds lost nearly $10,5 billion, as measured by Lipper. As a result, the Domini 400 Social Index (DSI 400) outperformed the S&P (Standard and Poor) 500 during 2002, as well as on a total returns basis, over a 10-year period. (This is calculated over a period ending 31 December 2002, with total annualised returns gaining 9,99 per cent against 9,35 per cent by the S&P 500 over the same period. In 2002, the DSI 400 fell 20,1 per cent and the S&P 500 22,09 per cent.)

In the wake of Enron and subsequent corporate scandals, funds that managed their investments, and especially corporate governance issues, more actively than the average US mutual fund have demonstrated enhanced performance through the systematic and broad management of risk issues. In August 2002, the US Social Investment Forum called on the US Securities and Exchange Commission (SEC) to extend the corporate governance reforms approved by New York Stock Exchange (NYSE), especially those dealing with non-financial disclosure, board election and executive remuneration. (The Social Investment Forum considers itself ‘the national trade association for the SRI industry’, with views supported by member submissions to the SEC, including Walden Asset Management, Pax World Fund Family, Harrington Investments, the Calvert Group, Domini Social Investments, Trillium Asset Management, the Corporate Governance Network and Citizens Funds.)

Mutually reinforcing social and financial performance has yet to be reflected unequivocally in South Africa, however. A major inhibitor of South African SRI is the failure of what are described as ‘targeted development investment’ (TDI) fund managers and stakeholders to establish consensus on key issues that would define SRI, including:

	how the asset class (a term used loosely to describe a set of funds ranging from property investments to bond allocations) should be defined
	how it relates to and supports Black Economic Empowerment (BEE) and vice versa, on what basis BEE is not appropriate and how empowerment is defined in this context (broadly, relating to social infrastructure, or corporate deals, or both?)
	how funds' social and/or empowerment (non-financial) impact should be verified and how this performance is reported to trustees as a component of overall performance (essentially applying the concept of the triple bottom line – social, environmental and financial performance – accounting) and
	how to position the funds and how they relate to SRI trends seen internationally.

Essentially, social performance has yet to be adequately defined, measured and verified by an industry forum, although initiatives such as the JSE's SRI index and GRI are adding momentum to the promotion of best-case practices for those seeking guidance. Alexander Forbes Asset Consultants' (AFAC's) TDI Survey (for the third quarter of 2002), asserts that SRI is viewed by the employee benefit advisers in the context of South Africa's Reconstruction and Development Programme (RDP) goals and not in terms of international trends. At this time, AFAC estimated that the 22 SRI funds under management in South Africa accounted for R9,8 billion or 0,58 per cent of South Africa's R1,7 trillion assets under management. This is far below the United States' 2,26 per cent by 230 funds, or the United Kingdom's 1,35 per cent, but above France's 0,01 per cent and Germany's 0,04 per cent of mutual fund assets, at the end of 2000. AFAC's data on the latest performance (as at the end of the first quarter of 2004) reflects a dramatic drop (50 per cent) in the number of SRI funds, but remaining funds have performed well, and represent a similar value for assets under management (R10.3 billion) as at the end of the third quarter. These figures are reflected in Table 1.

Table 1: SRI funds

Investment data (%) at end 1st quarter 2004
Fund information			3 months			12 months			5 years (p,a,)
	Classification	Size (R m)	Fund	Rank	Target return/benchmark	Fund	Rank	Target return/benchmark	Fund	Rank	Target return/benchmark
Balanced
African Harvest Balanced Benevolent Fund	Unit Trust	62,5	4,16%	1	1,26%	37,42%	1	29,75%	n/a		*
Corporate Wealth Development Fund	Pooled	302,0	2,39%	3	1,90%	22,43%	3	0,41%	10,56%	2	5,98%
Futurebuilder	Pooled	616,8	2,93%	2	3,38%	35,68%	2	8,61%	12,21%	1	11,68%
Equity
Community Growth Fund	Unit Trust	1 265,6	3,12%	3	3,68%	47,33%	2	43,76%	11,76%	3	14,20%
Frater's Earth Equity	Unit Trust	125,0	4,61%	1	4,68%	47,62%	1	47,68%	n/a		*
Futuregrowth Albaraka Equity Fund	Unit Trust	153,0	3,73%	2	3,68%	43,85%	3	43,76%	23,92%	2	14,22%
Oasis Crescent Equity Fund	Unit Trust	656,1	2,66%	4	3,68%	38,43%	4	43,76%	28,75%	1	14,20%
Oasis Crescent International Fund of Funds	Unit Trust	140,4	1,53%	5	*	15,18%	5	*	n/a		*
Alternative
Ideas Fund	Pooled	795,8	2,14%	2	3,36%	18,98%	2	7,27%	14,69%	1	12,65%
Sanlam Development Fund	Pooled	1 839,8	2,18%	1	*	30,10%	1	*	1,05%	2	*
Fixed Interest
African Harvest Infrastructure Bond Fund	Segregated	342,4	0,26%	1	− 0,05%	13,21%	2	12,59%	n/a		*
Community Gilt Fund	Unit Trust	617,9	− 0,12%	3	− 0,31%	12,73%	3	12,32%	16,52%	2	17,72%
Futuregrowth Infrastructure Bond Fund	Pooled	3 205,8	0,24%	2	− 0,31%	13,25%	1	12,32%	18,33%	1	17,72%
Property
Futuregrowth Community Property Fund	Pooled	300,4	2,47%	1	2,90%	14,33%	1	4,42%	12,93%	1	9,51%
Source: AFAC
Notes:
• Funds are not directly comparable given the range of investment methodologies.
• Money market funds are excluded, as is the South African Infrastructure Fund, Frater's Earth Equity Fund, the PIC's Isibiya Fund and Prodigy's Transformation Fund.
• Performance figures are gross of fees except for all the Unit Trust funds (net of fees).

What is highly significant, however, is the range of risk and returns over the past three-year period, as represented by a scatterplot drawn up by AFAC, shown in Figure 5.

Figure 5: Risk/return profiles

Another dimension of risk lies in South Africa's volatile currency. Owing to the rand's fluctuating value, local SRIs have proved a problematic investment for international investors. The Calvert South Africa fund, for instance, no longer exists and has been merged into Calvert's World Values International Equity Fund, which consists of a range of international stocks (personal communication, Calvert webmaster, 2003). The resulting local focus implies a greater role for South Africans in defining what is expected of SRI, financially as well in terms of contribution to empowerment and transformation.

Some lobbyists (as quoted in Thale et al., 2003) advocate government intervention in the form of prescribed asset allocation (as required under apartheid regulations). Experience around legislating desirable outcomes in social responsibility has been mixed. Where reporting mandatory requirements have been introduced they have encouraged sustainability reporting in some countries, notably in France, but others, especially where other forms of activism prevail, such as Denmark and the Netherlands, have seen companies complying only to minimum requirements (Adams, 2001). Other variables such as legal environments are also important: US companies are wary of possible litigation exposures through disclosure on non-financial performance and have reported less on sustainability issues than many European peers. Similarly, in the case of South Africa, forcing asset allocation may not result in increasing SRI as there is not the capacity or measurement infrastructure or, indeed, deal flow, for such funds. More flexible facilitation such as pension fund disclosure on non-financial consideration may be a better solution to ensure that members' needs are represented and protected.

5. Conclusion

If international trends are followed, ensuring that financial performance is to an extent underwritten by social responsibility, SRI may have a promising future in South Africa. These trends, however, need to be underpinned by greater exposure to and wider debate about what investors (including all those who contribute to pension funds) expect from the management of funds and greater levels of shareholder activism.

Controversy surrounding the restructuring of the Public Investment Corporation (PIC), as voiced in deliberations at Nedlac (National Economic Development and Labour Council – a forum for dialogue between labour, the private and public sectors), should take the conditions for SRI into account to ensure that the opportunities presented by SRI, from both a financial and societal perspective, are debated constructively so that sustainability can present a meaningful face in the investment environment.

Properly considered, South African SRI could present a valuable case study for developing countries trying to balance the various aspects of sustainability against pressing pension fund needs for financial returns. Further definition, industry identity leadership and conceptual support will be needed to ensure that SRI is properly tailored to develop beyond a niche industry.

Additional information

Notes on contributors

Karen Heese

Karen Heese is an independent economist based in Johannesburg, South Africa.