Speaker 0:
Joining me now in this exclusive interview for the E S G virtual conference, Anne Kaba Alehouse Practice Director of the Responsible Finance Initiative at the Gordon Institute of Business Science. Welcome back, Ann,

Speaker 1:
thanks Chloe. Thanks.

Speaker 0:
So and discussing the issues surrounding the indexing and benchmarking of E S G products. Perhaps we should start off with the issue of green washing or essentially what asset managers are misleading investors about outcomes, expectations of their E S G portfolios, the issue of indices and benchmarks. What are those issues? Um Exactly.

Speaker 1:
OK. So when we talk about green washing, what essentially greenwashing is all about from the investment perspective

Speaker 1:
is basically producing a product that you claim can do something,

Speaker 1:
but it actually isn't doing that. Ok. So that is what greenwashing and investing is. That's distinct from green washing as a corporate green washer in terms of green washing, what its products can do or green washing, what it's trying to do as a company. So you've got different aspects of brainwashing. We're focusing just on green washing and investing

Speaker 1:
and really that comes down to if you're making a claim that your product can do something, you've got to be able to demonstrate it, but it's actually doing that, which is why this whole issue is about how do you benchmark that?

Speaker 1:
How do you report on?

Speaker 1:
And

Speaker 1:
much of it, the confusion comes because what has happened over time is the asset management industry has typically used indices, market cap indices

Speaker 1:
to be a proxy for their benchmarks. So when you look at a regular asset manager and you ask the question,

Speaker 1:
did they add value? Did they not add value? They will typically go and say, well, I'll use the switch J S E switch index. And if I outperform that index, I added value. If I didn't outperform that index, I didn't add that.

Speaker 1:
And that is typically the way reporting is done,

Speaker 1:
but that doesn't work if you're making a claim that your E S G product is trying to achieve something positive. So you've got to get back to the first question, which is what are you suggesting your product in E S G is going to be able to do?

Speaker 1:
We need to get that clear to begin with? OK. And

Speaker 0:
then an perhaps just to distinguish then the difference between an index and a benchmark. And then why are we seeing a need for a completely different type of benchmark for in the E S G or sustainability and impact

Speaker 1:
space? Now, that's a really good question. So I I I suggested that over time, what had happened is that um

Speaker 1:
indices had become the proxy for benchmarks. And the reason why that became the case is because typically a benchmark is supposed to be what uh the investable universe is for an asset manager. And not every asset manager sort of operates in the same space, some will be small cap managers, some will be large caps, some operate in the value space. And so if you want to test the skill of that manager, the benchmark has to reflect the universe that you're likely to invest in.

Speaker 1:
And the problem is

Speaker 1:
those universes when I first started in asset management, that would become, that was known as your normal portfolio.

Speaker 1:
Unfortunately, the industry started to abuse what the normal portfolio was in such a way that they made their performance always look good to the normal portfolio. So investors pushed back and they said we want to have some external arbiter

Speaker 1:
that would determine what is a good index for that investable universe. So an index as opposed to a benchmark is typically the entire investable universe, I say investable because you'll notice that in South Africa, we went from the J F C to the switch. The argument being that the J F C wasn't fully investable to South African investors. So

Speaker 1:
the investable universe is an important indicator of the full opportunity that the investor has, but it isn't necessarily a good proxy for the kind of skill a manager brings to the table. So if I'm an E S G investor.

Speaker 1:
Um I have to be very careful what I say here because it goes back to what claim I'm going to make about being invested in E S G is my claim simply going to be, I'm going to be investing in companies that are um highly ranked E S G companies. Um in which case,

Speaker 1:
using a benchmark that is market cap weighted. In other words that it's waiting in the index is driven by its price as opposed to its ranking in terms of its E S G is not a very viable um proxy for that claim. Um If I'm

Speaker 1:
arguing that I'm investing in E S G because I really want to change the world that I believe that we need to focus more on environmental outcomes, on social outcomes, on governance outcomes. And I want to force companies to change the way they're behaving that again, simply investing in, in, in an index that shows what the current rating is of. That manager doesn't

Speaker 1:
tell you whether I'm adding any kind of value because it doesn't say is uh am I getting those companies to change what they're doing?

Speaker 1:
So we're really entering into a whole new world of benchmarking that really hasn't been challenged before. And I often talk about E S G as not. So, I mean, i it's, it's funny I have to teach a course this week on, on E S G one oh one and I said to the person who asked me to teach this, do not pull it one on one. There is no basic knowledge about E S G because it's a constantly evolving concept where it's like we're, we're flying the plane while we're building it as the usual expression.

Speaker 1:
So the benchmarking problem is very similar. We haven't quite figured out how to do it,

Speaker 1:
but we know in things like, um a lot of the work that was done around net zero climate, I mean, net zero um uh carbon emission uh commitments that fund managers tried to make that they couldn't just do a market calculated index because that was not demonstrating whether they were meeting any kind of targets that needed to be met to meet the Paris Alignment agreements of trying to reduce carbon emissions to 1.5%

Speaker 1:
or 1.5 degrees. Sorry. So your, your, your challenge is the benchmark has to reflect what you're trying to achieve. If you're trying to change the world, then that benchmark needs to be dynamic. It needs to have embedded in it. What are the targets that are going to meet, you know, those objectives like uh net zero emissions? It can't just be, is my company that I invested in better than some other company

Speaker 1:
because that doesn't achieve anything, you know, it could be all companies are there.

Speaker 0:
Absolutely. So then Anne, if we're now talking about creating indices using some other basis for company waiting, then their market cap, then how much stock should we be putting into these indices? If we still haven't got companies reporting against a set of standardized metrics?

Speaker 1:
That is such an important question. That is such an important question. And it's led to the fact that, um,

Speaker 1:
you know, you, you have this massive, you know, bum fight going on there about the different in uh data providers and the different indices providers about what the correct way to approach the problem is. That's, that's one set of dynamics, but the other set of dynamics is what information is the company giving you on which to make those assessments. So you can, you can have different criteria to make the assessment

Speaker 1:
and then you have different criteria that the company is giving you and no standardization there. And right now, the big debate, I mean, financial reporting is very clear cut. There are global standards that we'll all abide by in terms of what we have to produce to reflect or what we have to do to, you know, reflect some other financial um metric that everybody would use as an analyst to assess a company.

Speaker 1:
But we haven't reached a total agreement on what should be standardized around what we call non financial reporting.

Speaker 1:
And the two ways that you look at it are one, are we interested in E S G from the perspective of what the environmental and social and governance factors external to the company might do to the company itself.

Speaker 1:
In other words, how it might affect the financials of the company

Speaker 1:
or are we interested as investors

Speaker 1:
on what the company can produce that would impact the environmental and social and governance framework around it? And those are, what are we now think of as double materiality? So one is material to the company itself and the other is the company's materiality to the environment around it.

Speaker 1:
Now, the nice thing about what the J S E has done in terms of its sustainable reporting data suggestions and I'm saying suggestions because none of these things are in stone yet demanding on this kind of reporting is that they've tried to look at both because they argue investors, people like you and me want to know both, they want to know what's gonna impact the company in terms of its potential, you know, um

Speaker 1:
financial impacts, but it also wants to know whether or not the world is gonna turn against them because they are impacting the world around them. And I think there's something to that. But now you have

Speaker 1:
those two measures being represented by

Speaker 1:
two different standards of international um sustainability metrics, one being the I S S B on one side and the other one being the G R I on the other side, being worried about how a company affects the world around them. And even these two entities, even though they have a memorandum of understanding that they have to come together and come up with a standardized,

Speaker 1:
you know, metric. They haven't, they haven't done that yet. And more importantly, not only they have, they not done that and issued that,

Speaker 1:
but they also haven't

Speaker 1:
determine that this is, has, has to be mandated that you have to do this reporting. And more importantly,

Speaker 1:
you haven't required that there be an assurance um assessment given that, what, what's an assurance, that's an external assurance provider who goes in and says that company knows how to do that measurement. That number, that number that they have provided is correct, whether it's good or bad, that doesn't matter. But is that data correct? And you know, that's the kind of work that just takes years to get entrenched.

Speaker 1:
It took 10 years for the original I, you know, S P standards to get in, you know, mandated into um reporting standards. Now we've got to go to the next level. So

Speaker 1:
you can see this is really complicated.

Speaker 0:
So, um investors then are invariably using benchmarks to measure either our performance or underperformance. But you've argued that we need to create a benchmark or benchmarks that are either dynamic or embed specific scientifically based targets. How then does this change the way that reporting needs to be done and fund excellence um needs to be assessed?

Speaker 1:
Ok. Um Obviously, we're not totally there yet.

Speaker 1:
And the interesting thing about the F S C a is they understand that this is sort of in transition and they don't want people just coming up with any kind of benchmarks that they want to. So that they're saying that people who do produce these indices need to get their vetting services first before they go out and use them.

Speaker 1:
I threw the word reporting in there in addition to indexing and benchmarking because I think in a, in a way, the only way we're going to be able to manage this interim period where we're sort of, we still haven't got everything. All the pieces together is through the way that we report and communicate to investors.

Speaker 1:
So you may not be able to capture it numerically properly, but you can do a descriptive thing as to what you've achieved and what you're doing. Um Now, the problem that you have right now

Speaker 1:
is that a lot of investment houses tend to uh particularly if they want to show that by investing responsibly, they've made a great impact on society around them. They'll, they'll create all these metrics and we've created, you know, 50,000 jobs and we've done um uh we've opened up 10 schools in this district.

Speaker 1:
What it doesn't do is that it actually doesn't take it any further. It doesn't actually ask the question. OK, you've created 50,000 jobs. But were those jobs that were sustainable? Did they last any more than a year? Uh Were they just temporary jobs or were they poor quality jobs? Those schools, did they train people for better outcomes or did they just, did you just create the physical structure of new schools? So we've done a,

Speaker 1:
you know, in, in the past a lot of this stuff, um

Speaker 1:
that's done both by companies and by asset managers is really just marketing materials. You know, we've done all these wonderful things. Um So you haven't actually set up a standard that says, um how am I going to measure the quality of what I'm changing?

Speaker 1:
And, you know, I'm kind of a perfectionist and I'm, it's really easy for me to go in and, and criticize all these things.

Speaker 1:
But I also have to be pragmatic and realize we gotta start somewhere.

Speaker 1:
So I, I think

Speaker 1:
probably the best place to start is investor education, investor education as to what to look for, to understand that simply by investing in an E S G project that measures itself against the J S E or the six index doesn't tell you anything, doesn't tell you anything. Um It certainly doesn't change anything.

Speaker 1:
It might make you feel better as an investor, but you haven't changed the world by investing in these things and you haven't changed the world because

Speaker 1:
my

Speaker 1:
buying a company that has a high E S G rating,

Speaker 1:
that money that I've invested in that company doesn't go to the company. It goes to the person who sold me the share.

Speaker 1:
I haven't asked the company to change anything,

Speaker 1:
there's no shareholder engagement involved here. Um There's nothing I just made myself feel good because I've invested in these kind of shares, but I've done nothing by doing that. That's an

Speaker 1:
or

Speaker 1:
thing that investors often fail to understand.

Speaker 1:
If I'm investing to do something, then I need to understand how, how is that company reporting on how they're doing it? So you can keep challenging that service provider. How are you actually demonstrating

Speaker 1:
that you're doing this climate change is pretty easy because we know what targets companies have to meet to meet their net zero. Um It's, I, I say it's pretty easy but it hasn't really been rolled out. At least we have the science based target sort of generally understood for each industry and for each company and you can measure the company so you can actually look and see whether the company is changing,

Speaker 1:
but I don't know of any asset manager who's using that kind of a benchmark right now. And we have to start using these things if we're going to start using this kind of E S G investing to actually have any kind of impact whatsoever. Otherwise we're just, we're just,

Speaker 1:
you know, um allowing a whole new range of products to exist that we can throw money at that. Don't do dili shit. Absolutely. I am allowed to use that word.

Speaker 1:
Yeah.

Speaker 1:
So, and then

Speaker 0:
what do you feel will be the most relevant to South Africa and E S G investors going forward. Would it be globally sanctioned and formulated indices or locally designed?

Speaker 1:
Look the problem that you have with globally sanctioned. Um Anything

Speaker 1:
um is it works on a kind of least common denominator basis? You know, how can I come up with standards that will apply to thousands and thousands of companies all over the world?

Speaker 1:
South Africa has very unique challenges. You know, we have a just transition that we have to address. We um in terms of our energy commitments, we've got um inequality, we've got transformation that we have to uh address.

Speaker 1:
So if you're a South African investor who's concerned about using your investment funds to change South Africa, which is actually,

Speaker 1:
you know, on the other reason why you should consider E S G if that um you know your, your moper, um then we need to have South Africa specific

Speaker 1:
targets and indices and we need to start working.

Speaker 1:
Infrastructure is a, is a really good example. We've got

Speaker 1:
an investment opportunity set opening up for infrastructure in 28 up to 45% of your portfolio can control infrastructure, but we have actually no benchmarks

Speaker 1:
that reflect whether your, how your infrastructure investments are doing. We have no indicators as to whether or not

Speaker 1:
that's not specifically E S G, that's just infrastructure in general, we don't have any.

Speaker 1:
But if you were to throw E S G on top of the infrastructure investment and ask the question by investing in infrastructure.

Speaker 1:
Did I further the cause for environmental protection or social lift? Then I need another whole set of, of benchmarks embedded there. Now that work is being done globally, there's been a lot of progress that's been made on it.

Speaker 1:
We just need to get together as a collective here in South Africa, as an industry collective, as an asset owner collective and go to these people that are developing these things and saying, please come in here to South Africa. We'll make it worth your while. Let's develop this for South Africa.

Speaker 1:
And that's what we had to do years ago. When we were trying to build the risk models for South Africa, we had to say we have such a unique sort of way that our market operates. We need to develop risk models specific to South Africa. Otherwise we're not gonna achieve the benchmarks are just gonna be too airy theory and not really uh achieve anything for investors. Absolutely.

Speaker 0:
So, and then would the regulator then need to step in here in some way? And if so how do they do

Speaker 1:
this?

Speaker 1:
Look? I think the regulator is stepping in to the extent that they're saying if we're going to create these benchmarks and indices come to us first, um I mean, we're trying to talk to the regulator as well as Gibbs and, and, and sort of say, look, um

Speaker 1:
what would these benchmarks have to look like to match for you to be able. We're saying that for the regulator, their primary concern is greenwashing. Ok. Um They haven't really got the mandate from government yet to do

Speaker 1:
uh climate change because we've got so much disagreement at the top in terms of what that entails for the industry. But we do have the regulator um beholden to make sure the products that financial service companies offer, do the things they say they're gonna do.

Speaker 1:
So, um that, from that perspective, I think the regulator can be a lot more proactive in helping um identify what kind of benchmarks go to what kind of products.

Speaker 1:
But it, it, you know, you cannot operate out of the world of this is what we've always done. We have to really talk in terms of what do we need to do going forward. That's gonna make sense. And that, that, that's, that's an investment in research and time and energy and your typical financial service company and your typical regulator simply doesn't have the capacity to do that.

Speaker 1:
So in a sense, we need a partnership and a collaboration that brings together those entities as well as, you know, the academics who do silly things, like focus on this stuff like us and say how, how do we actually do this? But you've got to make it worth everybody's while to do it.

Speaker 0:
Absolutely. So, Anne with all of this focus now on E S G and benchmarking of E S G products. What is the outlook with regards to the implementation of some of some of the developments?

Speaker 1:
Um The outlook is gonna be dependent upon how, how prepared we are to collaborate. Um You know, the problem that you have in this industry is we look at each other as competitors. And so we look at any new idea that we bring into the industry as our competitive advantage.

Speaker 1:
Um I went through this years ago, back in the 19 eighties and 19 nineties around things like wrist models. And I had to convince our member in Japan,

Speaker 1:
uh big competitors like Mira securities versus NICO securities that just by developing code, developing a risk model, they were not um giving away important intellectual property to each other. But everybody needed a risk model and everybody needed to agree on what the principles were on that risk model. The same is gonna be true about these benchmarks and the same is gonna be true about these indices and targets and what have you. We have to get together and, and

Speaker 1:
put in the time, the effort and the money to develop these things for South Africa and collaborate because getting systems change in this country, getting societal outcomes is not a zero sum game. You can't have some winners and some losers. If we don't all win, we're all stuffed and

Speaker 0:
all on that note. Thank you very much for sharing your insights into the index and benchmarking of E S G products. We appreciate your time.

Speaker 1:
Thank you, Chloe. Thank you.