Through the different market cycles and changes in political regime, there has been rigorous debate about the place of environmental, social and governance (ESG) policies in investment, and more broadly corporate social responsibility and diversity, equity and inclusion in corporates.
The ancient philosophers have long debated issues of ethics and morality. Greek philosophers Socrates, Plato and Aristotle emphasised intentions. The focus was on moral knowledge and inner virtue. This is echoed by Nguni philosophies such as ubuntu, with the term itself derived from Ntu, the patriarch to the Zulu, Xhosa, Swati and Ndebele nations, whose people are referred to as aba-Ntu. This philosophy has a stronger emphasis on community and relation.
The Greek philosophers Epicurus and Cyrenaics emphasise the outcomes of actions, with pleasure and mental peace as a moral goal. This is similar in the Igbo nation, which emphasises acts that promote life, health, balance, moral virtue and community.
Stoicism from ancient Greece and Rome emphasises a rules-based approach, with a focus on duty, moral law and rational self-control. We see this echoed in the Yoruba nation and customary law throughout the African continent. Each of these has its own merits and fair share of criticism, but combined they provide a robust framework for thinking through issues of morality in the context of corporate citizenship.
The largest criticism, particularly of ESG, is underperformance during certain market periods. For instance, during the Covid-19 pandemic recovery, which induced excessive demand for energy and supply-side shortages as Russia, a major energy player, was sanctioned, Brent crude oil rallied in excess of 400% between 2020 and 2022. Investment strategies that did not include energy companies lagged the market.
Most recently, with elevated geopolitical tension across the globe, the US and most European nations have increased their military defence budgets to 2%-4% of their respective GDPs. As a result, counters engaged in military defence have more than doubled in value over the past two to three years. This has meant that investment strategies that do not include these companies have lagged the market yet again.
Another criticism is the consistency of definitions and ESG scoring across different companies and geographies, and through time. Looking at military defence companies, they have varied scores across these spectra. This boils down to perspective and definition, whether investing in them is seen as funding wars or as providing countries with the means to defend their sovereignty against invasion and terrorist acts for the purposes of peace. Furthermore, the products that defence companies such as Raytheon provide are wide and varied, from missile systems, integrated defence systems, aerospace, intelligence and general engineering — making it hard to place them in a singular ESG category.
The prioritisation, particularly between environmental and social issues, is also a challenge. Emerging economies like as ours typically have greater reliance on fossil fuels such as coal, and greater social challenges such as unemployment, poverty and inequality. By contrast, developed economies tend to place a stronger emphasis on environmental issues, as their standard of living is at a reasonable level.
However, these are not justifications to abandon the principles behind initiatives such as ESG. They simply highlight some of the complexity that the solutions need to address. Standardisation within this area is something that will be developed over time. Measurement systems and targets need to be cognisant of the starting point of each region, which policies such as the Just Energy Transition from COP27 recognise.
Screening companies upfront as good or bad investments is not sufficient to implementing a workable ESG framework, particularly in the case of local markets, which limits an already limited investment universe. Rather, a thorough understanding of companies and their practices is required, involving a direct comparison with their competitors to pick out the ones with more sustainable business practices from an ESG perspective. In the case of Raytheon, it is a leader in both environmental and governance issues within its industry. From a social perspective it also tracks above its competitors and is strong on community rights and relations.
From a philosophical perspective, the intention of ESG policies is to factor in external costs of doing business that the environment and the rest of society pays the price for in the long-term. ESG also aligns with the values and principles that we have, which are anchored in trust, resourcefulness, stewardship, inclusion and courage.
On an outcomes-based approach, it is to preserve the planet, limit climate change and ensure fairness and inclusion across societies. From a wealth trend perspective, the increase in digitisation, access to information, transparency, wealth transfer across generations, gender and geography has increased the demand for purpose driven investment. Looking at the long-term investment perspective, there is a positive correlation between sustainability and wealth generating returns, with some additional tailwinds for new industries to invest in.
Even Milton Friedman, who authored the essay “The Social Responsibility of Business is to Increase its Profits,” may have found the arguments for ESG compelling, particularly given a longer-term sustainable return lens. In addition, the responsibility of increased profits is premised on the rules and ethical customs, which are both increasingly demanding that we consider ESG in our investment philosophies and processes.
• Smith is chief investment officer at Absa Investments.
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