Investing in private equity

[00:01] Introduction - private equity as an asset class

[03:25] What distinguishes private equity from listed equity?

[05:24] Due diligence and private equity strategies

[12:31] Where private equity fits into diversified portfolio

[18:17] Accessibility of the asset class and the stages of private equity

[25:52] Conclusion and final points

[0:00:01] Introduction – private equity as an asset class

Ayabonga Cawe: So, in this episode, today, we stick with the theme of alternative investment classes, and I’m joined by Kate Dugan and Sohan Singh, who are both from Investec Wealth & Investments and we unpack how to incorporate private equity into an investment portfolio and how to invest in this asset class sensibly. Kate is an investment manager with experience in wealth management in the United Kingdom, having previously worked for a hedge fund in London and as a wealth manager in Liverpool, before returning to South Africa to work at Investec. She’s a mother of one and before the arrival of her baby, she enjoyed offroad and camping trips all over Southern Africa, riding motorbikes through Morocco and Portugal, but is now a year and a half into her new role as a mother, and at the moment her main hobby is being chief snack maker for her son. Sohan joined Investec Wealth and Investments in 2012 and is currently a wealth manager. He works on developing solutions for high-net-worth individuals and ultra-high net-worth clients, being fully au fait with offshore and local investment opportunities. Sohan is married and enjoys travelling and spending time with his family and friends and enjoying a good whiskey. And he’s also recently taken up padel and enjoys a weekly game. Sohan and Kate, welcome, and I guess as we go into our discussion, I wanna start with you, Kate. When people talk about private equity, or PE, what are we talking about?

Kate Duggan: Yeah, it can be tricky, so essentially what we’re talking about, is investment into a business and that business is privately held. So, not listed on a public stock exchange. The investment that goes into the company is then used by that company to essentially get better, be it funding new technology, creating new products, making acquisitions, or otherwise expanding or improving their business. So, the route for most investors into private equity, will be via investments in a private equity fund that will hold multiple of these businesses. This fund will be managed by a private equity firm of individuals, and they’ll have influence over the management and other sort of big decision-making options within the company. And that’s really one of the main tools that they’ll use to steer these companies through performance improvement of any sort, and they will either turn around a distressed company that wasn’t performing very well or improve a company that has been badly managed or under-managed, or under-valued. And the ultimate aim is to increase the business’s value and eventually sell each company that they’ve worked with for a profit, which is beneficial for the company that’s gone through the process, the private equity firm as well as the investors that provided the initial capital, and that sort of sale is most likely done through an initial public offering. So, you know, offering on a stock exchange which we all know, or sale to another sort of public company.

[00:03:25] What distinguishes private equity from listed equity?

Ayabonga Cawe: From an investor perspective, what would distinguish private equity from listed equity? Be it from a risk perspective, or even I guess the time horizon to realise returns?

Kate Duggan: So, the big thing there, you know the big buzzwords there are public and private, and that kinda tells you everything you need to know. The big differences between private equity investing and public equity investing, or investing on the stock exchange, which is public, are sort of the main points about liquidity - how accessible is your investment? The pricing control, how often are these two options priced, the measurement or how they go about pricing them, the governance, and the performance measurement. So, it can get pretty technical, but the main difference for most investors to know about, is liquidity and it’s a biggie.

You know, listed equities are generally able to be sold in the market at their current fair value. Private equity [investments] are generally not as liquid and essentially, they usually have a primary term, or a life, by which you have to stick to, and that’s because they’re going through this huge change which we’ll chat about later, but that primary term can be five years, seven years, sometimes even ten years, to see that change, and so patience is really key there. And, whereas you can buy a stock on a public exchange and sell it couple of days later, a couple of weeks later if you wanted to, with private equity your capital is only really returned to you upon the realisation of the investment, which is the sale of the underlying company and that really is at the fund manager’s discretion, because they need to search for a buyer for those companies. 

The last point I had to make, is other than liquidity, it’s pricing. So, you know, you’ve got your public stocks that we all know about, priced every day in the market. Anybody can click on Bloomberg on their phone and get an up-to-date price for what they’re looking at, whereas private equity, you gotta be a little bit more patient, and you’re probably only gonna find their value every sort of quarter if not less than that. So, there’s a big difference there and I’d say, you know, each carries risks, and you can get sort of quite philosophical on, on which is riskier, but based on those, you know, illiquidity and, and pricing, I’d say that private equity tends to rank a lot higher in terms of risk than the public equity that we all know.

[00:05:24] Due diligence and private equity strategies

Ayabonga Cawe: And I guess, Sohan, let, let me bring you in here, because I think the points that Kate is making, all have an implication on the type of information and symmetries there might be between an investor on the one hand and the firm in question. Uhm, so, even the issues around pricing, the issues around governance, the issues around the kind of yield one might expect for taking such a big risk. All of those things mean you kind of have to do a lot of your homework upfront. Uhm, talk to me about, I guess, what kind of due diligence goes into a private equity investment, and more importantly, I guess, what might distinguish that from an investment made in a public-, publicly held company, where certain information about that company is public and available to the entire investor universe.

Sohan Singh: Thanks, Ayabonga. Those points that Kate raised, are the reason why it is so important to partner with experts in the industry. So, if we had to look at a listed company, you’ve got hundreds of analysts looking at those financials, doing their homework on it. Everything is readily available. It’s all published to market, whereas with these unlisted businesses you don’t have that same level of information. You don’t have, a whole port of analysts digging through the financials. So for example, if you invested in a private equity fund, it would require the analysts of that fund or that management team to actually get on the ground, and go look at these businesses, see what they’re doing on a day-to-day operations basis, see what their strategies are, look at their financials, and it involves a lot more in-depth work, and a lot more due diligence work, behind the scenes. And that’s often why it takes a longer time period before any private equity funds makes these investments, because of the lengthy due diligence process that is involved.

Ayabonga Cawe: And, and I mean, after that due diligence process, I understand there’s quite a few strategies that when thought of together, constitutes, you know, private equity. We often always see it in the sort of popular culture the story of the leveraged buyouts and all of that, but it seems there’s quite a bit more at, under the bonnet of private equity than maybe just leverage buyouts. Talk to us about some of the other strategies.

Sohan Singh: Sure, and I think the best way to explain the difference between strategies is to look at it in terms of the company life cycle. So if we look at a start-up company, very early stages, this probably falls out of the equity spectrum, but just for the sake of this conversation, I wanna take you through the whole spectrum. They say that in the very beginning when these businesses start, that stage of funding, we would call it FFF, which stands for friends, family and fools, and essentially, end up going after anyone in the market who’ll lend you money or give you money to start a business. So that is really, really early stage where you’ve just got an idea. You then go on to angel investing, which is still one step below the private equity spectrum that we’re talking about today that is essentially a form of private equity and that’s still very early stage in the life cycle of the company. In terms of the three main types of private equity strategies, I would class them as venture capital, growth equity and buyouts. So, after your early-stage investments, somewhere between early in your growth phase, is where the venture capital strategy comes into play, and this is, like I said, very early on, after the business has exhausted all its other sources of funding, it then looks to the market for equity partners. And I think what’s very important in the venture capital side of things, is venture capital partners that actually add value to the investments that they make. So, not a fund or a venture capital fund that merely just, buys a stake in a business, and it’s generally a minority stake in the venture capital stage. You want a venture capital partner that actually adds value in terms of efficiency, a growth strategy,y to building that underlying business. Then we move on to growth equity. Growth equity sits somewhere between venture capital and buyouts. So, it’s more of an established business, but a business that’s gotten to a point where they really need additional funding to grow. Once again, this is probably not a majority stake in the business, but here it is quite important for your private equity partner to add value. And I think that’s a consistent theme, and I’m gonna go back to the point around partnering with experts, so, if you had to invest in a private equity fund, you want a fund that has expertise and that can assist these underlying investing companies and leveraging their businesses. The third private equity strategy that I’m gonna mention, is the buyout strategy, and this is the most mature business that you buy and this is, let’s call it one step before listing on an exchange, or an IPO. So, often the exit from from a buyout strategy is to list the business on an exchange. Sometimes it’s bought by another private equity business, essentially this is where a company or a fund takes a majority stake in a private equity business, and the strategy there is for the private equity company to actually have control and be in the driving seat of that business from a strategic perspective in a growth perspective.

[00:12:31] Where private equity fits into diversified portfolio

Ayabonga Cawe: Kate, let me bring you back in into our discussion. And Sohan, thank you very much for that description I guess, of the different strategies, or that sort of typology of the different strategies one might find. I think many people listening to us, Kate, would be interested in sort of where this very high risk, high yield potential, you know, asset class might fit into a diversified portfolio. A different sort of life stages of an investor and different risk appetites. Talk to us about that.

Kate Duggan: For sure. So, I know the listeners should be now, based on the previous episodes, au fait with asset allocation and the different asset classes of a portfolio. So, if we talk about asset allocation of a portfolio: equities, fixed income, cash, property, etcetera. Private equity sort of slots nicely into the asset class known as alternatives. So, when you’re talking about a portfolio managed for an individual, the size of the allocation to alternatives as an asset class is driven by a lot of factors, which will be bespoke for that particular individual, and their need, but typically if we look across our own global investment strategy groups, the best recommendation as to the different asset class allocations, this should be between 10, maybe even five in the case of private equity, but let’s say alternatives between 10 to 20% of your total portfolio and the size of the allocation within that private equity will be you know, constrained by a lot of the factors we’ve already talked about, the main one being liquidity concerns, but the allocation should be well within that band of 5 to 20%, for most investors being the concerns that we raised earlier, like the pricing and the illiquidity.

Ayabonga Cawe: So, not the kind of thing you want to take into retirement, right? I mean where your liquidity preference is much higher than say, if you’re a bit younger and you’re still in the job and getting a salary and putting some money away.

Kate Duggan: Sure. Although saying that, one of the main investors in private equity, as a sector, will be pension funds. So, again it does fall back to Sohan’s point of partnering with a proper partner, who knows what they’re doing because you know, we can get into it, but with the private equity due diligence, doing your homework. That’s gotta be key, and so it applies to a lot of different investors, depending on your timeline, depending on your liquidity needs, but I’d say if you really want to do your homework, it’s best to go with a proper partner, and whether that is a discretionary investment manager, or any other route. The point is doing your due diligence and making sure it’s suitable for you as an investor is just, it’s, it’s key.

Ayabonga Cawe: Ja, I think a lot of us listening to this discussion would probably have exposure to private equity via institutional funds, and you’ve mentioned the pension funds, and there’ll be many other institutional vehicles, but there are also people with very deep pockets who, I guess, would go into these in their own right, or in the right of their own families and so on and some sophisticated investors as well.

Kate Duggan: For sure. So, historically if we look at private equity, it was really reserved for the institutional investors and the sort of ultra-high net-worth individuals who could dedicate substantial sums of money for extended period of time. So, what hasn’t changed, is the level of patience that you need. So, private equity, as we’ll talk about, follows a long timeline and patience is key, but the asset class is becoming more accessible to individual investors through different mechanisms, one of them is the listing of private equity firms on the stock exchange. Others are multiple companies being held within private equity funds, which are dropping their minimums and therefore becoming more accessible. So, the asset class itself can offer really compelling returns and that’s what makes it attractive to all investors. We all want higher returns, but the point is that higher returns can carry higher risk, not at least being the illiquidity of the asset class itself. So, it might not be suitable for everybody. It can be incredibly complex. You’ve heard Sohan go through the different mechanisms, all of which can be incredibly difficult to understand for the average person and so, again given that it’s so complex it’s a really good argument to make sure that you are going through a really good fund with a high quality management team who are able to handle all of that necessary due diligence and governance and operational decisions that come along with investing in private equity, which most investors I’d say, are probably not interested in doing themselves. Whoever you are as an investor, and you’re looking at private equity, ja, manager selection, quality due diligence are both the essential elements that you need to look at. And you can sort of bypass a lot of those decisions by doing your homework on what is a quality fund.

[00:18:17] Accessibility of the asset class and the stages of private equity

Ayabonga Cawe: So, Sohan, let me bring you back in here, and I maybe, wanna piggyback on the point that Kate had made and get some of your reflections before we get into the different stages in a private equity fund’s development, but this whole point around private equity becoming a lot more accessible now. I mean, I guess there’s an upside to that, because of this exposure of even retail investors to a high-risk, high-yield asset class, but one would think there’s also some downsides as well, Sohan. Maybe just your reflections on that before we get into, I guess, the different stages from raising funds, asset allocation and then, of course, the long gestation periods sometimes associated with these investments, but just on the accessibility issue first.

Sohan Singh: I think from the increased accessibility point overall, my view is that it is a positive one, so we are getting further flows into the sector. One of the biggest things that I believe could happen, and I’d like to see happen, is fee compression within the private equity space. So traditionally, private equity or private equity fund managers haven’t necessarily charged the cheapest of fees, but once again it’s because of the enhanced due diligence. So, you do have to have teams on the ground doing this enhanced due diligence, but as we get more flows into these funds, I think over time we may see fees in the private equity sector come down. So, I think that’s a positive. Another positive is giving opportunities to people that haven’t previously had those opportunities to earn these enhanced returns. I think for me the one negative that we really need to be careful of, is we must always remember that this is a high-risk investment. And while it may be available to more people, not everyone should invest in a private equity investment. And I think Kate did allude to the fact that, if you require income from a portfolio, your asset allocation will look very, very different. So, someone that is in their retirement phase and requires to draw down on the portfolio probably shouldn’t be investing in a private equity investment, even though they could. I think private equity is generally something that more sophisticated investors invest in and not if you don’t understand the risks associated with the private equity investment, or the liquidity constraints of private equity investments. It can be a very dangerous investment for you.

Ayabonga Cawe: And then, Sohan, I guess there’s an entire set of stages associated with putting a fund of this kind together. I mean we’ve spoken a lot on the investment side of things. But let’s place ourselves in the shoes of somebody who might want to set up a private equity fund just for a second, there’s quite a bit that goes into it, I mean you spoke about the due diligence part which is a critical phase in the raising of the capital, but then of course at a fund level, there’s then the capital allocation decisions. There’s then the volatility of the returns phase and then hopefully there’s a phase where people get to cash in on their investment. Talk to us about that.

Sohan Singh: Sure, and I think the best way for me to take you through this, let’s call it the journey of your private equity investment, for the purpose is this example. I’ll assume that you are invested in a private equity fund and the management’s done by a private equity partner, and essentially, the first point of the journey, is making the decision to commit to a private equity fund. So, you will then sign a commitment agreement with the underlying fund manager. The capital isn’t called on Day 1 and that’s quite different to a listed fund or fund with listed instruments where you put your money into the fund, and it is invested on Day 1. Given the nature of private equity, the fund management team actually needs to go out there and source these deals. And there’s often a lengthy negotiation process around the price of the underlying investments. Obviously, the private equity fund will try and negotiate down, and the seller wants to get a bit of a bang for their buck. So, it takes a period of time and we then move into what we call the capital call stage of the fund and as these investments are identified, the private equity fund manager will then draw down on your commitment and you will pay into the fund and those funds are then allocated to the underlying investments. What we generally see happening at that point in time, is what we call the J-Curve, where your investments may start going negative almost on Day 1, and the reason for that is that some of these transactions are costly to put in place. You know, there are lawyers that would need to be involved, there are corporate finance individuals that are involved in concluding this transaction, and that does come at an expense. There’s also management fees from the fund manager itself. And that essentially gives you a scenario where the portfolio starts to go negative and as we start seeing the performance of the underlying investments coming through, our private equity fund manager is now creating some efficiencies within those companies, if necessary, creating management changes and really starting to leverage that business. We then see that valuation tick upwards and it then makes that J-Curve pattern that I talk about. And as we go through this J-Curve period we will start seeing distributions from our private equity fund. So, distributions or return of your capital or profits don’t necessarily come at the very end so some funds will have a five-year period, some funds have a 10-year period. It doesn’t necessarily come all at the end. It comes out as and when there are distributions from the underlying companies, whether that’s in the form of dividends or the private equity fund manager has sold out of a specific position. And you will then start to see distributions throughout the life cycle of the fund. And once the fund is fully invested, the fund manager moves into what we call the harvesting phase. This is essentially where they are looking to exit the underlying investments. What’s quite important, and it goes back to the point that Kate made earlier, around valuation, so a private equity fund has a number of underlying businesses as we know. Those businesses, while they’re held in the fund, are essentially valued on paper. So, the fund management team will look at the earnings and then put a multiple on it and have a valuation that’s a paper valuation. You want that valuation to be quite conservative, and essentially that valuation isn’t really real until that business has been sold. And that also adds to this J-Curve effect because you want to conservatively value on paper and once you exit that business, you’re hoping to exit it at a multiple of your initial investments.

[00:25:52] Conclusion and final points

Ayabonga Cawe: Maybe then just, I guess a last one, from the pair of you, and Kate I’ll start off with you and wrap up with Sohan. I think Sohan’s last point there is critical, which is, time is probably one of the key variables here, and often people speak about the time value of money, the opportunity cost to putting money down and into certain areas and while you might conservatively value a company, your expectations of what you’re gonna get out of it must probably compensate you accordingly for all of the opportunity cost of putting your money behind such a high-risk area. Just some parting reflections for our listeners who might be considering this as part of a broader diversified portfolio, or even going into a private equity plan in their own right. What would you have to say?

Kate Duggan: Sure. I think like all aspects of investing, and maybe it’s just for people like myself and Sohan, but it can be really exciting and I think we often tend to forget that the main aspect of investing is you are lending capital that you’ve worked really hard for as an investor. You’re lending it to companies to go create products or services that really should aim to make people’s lives better in whatever aspect, and that can be really exciting to be part of products or services that change the world. And so, private equity, from a philosophical point of view, can capture the essence of that, because you’re getting in right near the start, in terms of venture capital, or you are helping turn a company round that has been pretty badly managed or is distressed. So, it can be really exciting. It can be a really interesting process to follow as an investor, to follow the journey of those companies that you are lending your money to, but on the flip side of that, you’ve got to keep in mind the risk, because it is risky to turn around a company or to create new technologies or products. You’ve got to have a lot of patience because it’s not gonna happen overnight. The best thing you can do is be a long-term investor in whatever asset class, particularly private equity. And then lastly, I think we’ve banged the drum on this quite a bit, but partnering with someone who is top-notch, and is gonna do that due diligence for you because that’s really the crux of where it can fall, or it can be a great investment.

Ayabonga Cawe: Sohan, you have the last word.

Sohan Singh: Thanks, Ayabonga. I think for me the most important thing is to weigh up the risk in return for what you’ve invested. So, if we look at the risk-return element, this is a high-risk investment, so you expect a higher potential return, and the word potential here is very important, especially in those asset classes you are taking on a high amount of risk, but your higher return is not guaranteed, and for taking on that higher risk, you want a higher potential return. You also wanna be compensated for the lack of liquidity. And those are the key points from my side.

Ayabonga Cawe: Awesome stuff. Kate and Sohan, thank you to the pair of you for your time, and I certainly know for many of those who listen to this podcast and doing so as well, and to you, the listener, don’t forget to tune in to the next episode in this series. We will once again be in conversation with our experts from Investec Wealth & Investment. Until then, take care.

[00:04] Introduction - cash as an asset class

[03:58] Cash as a source of liquidity

[06:10] Cash as a starting point in investment

[10:47] Cash and life stage

[16:41] The expanding definition of cash

[18:48] The growth of income funds

[22:55] Corporates and cash

[26:20] Money market investments in a rising interest rate environment

[28:35] Is it still worth carrying cash around?

[0:00:04]  Introduction – cash as an asset class

Ayabonga Cawe: Is cash really king? That is what we will find out in this episode of the Wealth Creation Podcast Series. Today I am joined by Bronwen Trower and Glen Copans from Investec Wealth and Investment. Bronwen is a fund analyst at Investec Wealth and Investment. Her focus is on funds and offerings that pertain to credit, income, unlisted and alternative investments.  She enjoys short runs, long afternoon sunsets with sundowners, and time with friends and family. Glen, on the other hand, is a senior portfolio manager at Investec Wealth and Investment. His primary focus is the management of alternative investment funds and products to retail and institutional clients. His passion for sport and especially watching his beloved Liverpool Football team, allows him to unwind from the markets and seemingly, never walk alone whilst enjoying time with friends and family with a whiskey in hand. Bronwen and Glen, thank you very much for joining us today, and yes, today we want to talk about cash and Glen, let me start with you. When we talk about cash as an asset class and as something that features in one’s portfolio, what effectively, are we talking about, I mean, are we talking about the Randelas in my wallet, or are we talking about something else?

Glen Copans: Yes, that is an interesting question, Ayabonga. I think it is, it tends to be quite an interesting component when you talk about cash, it is all-encompassing. There are many different derivations of what it is. I mean I think if one starts at the most simple, foremost components of what it is, it is kind of cash in hand, the notes and the coins that one has. Then there is moving up as cash as an asset class, so, that becomes where it becomes a form of investment. So, the one is a component of legal tender, cash is easily transferable from one person to the next. It is used to pay for goods and services, but when you start moving into an investment component, it forms part of a broader portfolio. So, cash is equivalent to a low-risk alternative investment. It is the starting point of all your investment components that you have, but what it is, is effectively it has specific characteristics that people tend to utilise, but, I think from its most foremost component, ultimately one needs to consider that it is an exchange of an agreement or tender, where someone gives a form of money for a promise of a delivery, a service or from an investment component, some type of end investment goal.

Ayabonga Cawe and Bron: We often hear, I mean, all of the lexicon and the terminology that certainly trips up a lot of people. Money market funds, notice deposits and the like. Maybe just unpack for us, I guess, the wide diversity of the low-risk and very liquid alternatives that Glen has been talking about.

[0:03:58] Cash as a source of liquidity

Ayabonga Cawe: And I guess, the other dynamic Glen, I mean, just from Bronwen’s response there is, we often focus when we think about money just on the transactional requirements that it is able to meet, so, I want to pay you something, and if I have cash on hand, makes it a lot easier, but there are also then, I guess, other issues related, as with any investment insofar as preference for risk, preference for liquidity, and of course, I guess, where one might be in their own life stage and what requirements for cash that might give rise to.

Glen Copans: Sure, I mean, I think the one kind of enduring characteristic or the number of enduring characteristics that all of these elements of cash have, is that effectively they are liquid. So, it means you can utilise it in some shape or form, quite quickly and they are predictable, so, you kind of know what you are getting, even in an example, as Bronwen alluded to fixed deposit,  what interest rate you are getting, so,  in three months’ time, if you have taken a three-month fixed deposit, exactly how much your R100.00 is going to be worth at this point in time. It is predictable, so it gives a lot of predictability around that and there is an… large elements of kind of capital preservation. So yes, nothing comes without any undue risks, so one needs to be cognisant of the different risk elements that you have within that, but people look at cash as kind of your risk-free component. So, you are getting a lot of capital preservation, but there are certain risks that you need to understand, and different components of different products have different risks. So people have a different tolerance for risk, but a different product, ultimately, has a different risk profile, and it is important to understand, you cannot lump all cash investments into the same bucket, because you need to understand, what are the restrictions, is there… can I get my cash out immediately, does it take a period of time, is there some form of additional risk that I have taken for to try and enhance the return that I have effectively got? So, when one is plotting it from a risk tolerance perspective, you definitely need to be cognisant of the type of product that you are inferring.

[0:06:10] Cash as a starting point in investment

Ayabonga Cawe: And Bronwen, I guess, just based on what Glen has said, one of the biggest risks to the purchasing power of money is time. If you want to see that, go and look at a catalogue for vehicles from the 80s or the early 90s and think about how much you could buy a car for. How do we deal with that? How big a risk is that? Because R1.00 today certainly cannot fetch you as much as maybe R1.00 did, say, in early 2000.

Bronwen Trower: 100%, I mean that is a huge component of this asset class, is that especially in today’s times, it is not always beating, what we are calling inflation, the fact that your money today is not worth what your money is in that same 100, in a year’s time.  I that there is a couple of ways to look at it, like Glen said, there are ways that you can enhance this cash component, but when you do that you need to give up something. So, you give up the liquidity or you are taking on more risk. The other side of that though is then you have to move up the risk spectrum in terms of the fact that you now have to leave cash behind, move into fixed income, or move into kind of equities. That is how you tend to beat it, but that is going up the risk spectrum. So, I would call it a downfall, I do not know if you would agree Glen, a downfall of cash is that, at all points in time, you may not necessarily be beating inflation, but sometimes that is not your ultimate outcome for this investment class. The ultimate outcome for this investment class often is accessibility, so liquidity of that cash, and protection of capital, not necessarily a growth asset.

Glen Copans: Yes, I think if I can add, I mean, I think the important component, when you think of cash as an investment tool, is theoretically, cash is a starting point of all investment decisions. So, you start with a pot of money, and then you determine, based on a person’s risk profile, their specific needs, and objectives, where they are in their life stage. That will then determine how you construct the portfolio and how much you move away from cash, because effectively, cash is considered as the starting point, as you are risk-free, and as you start moving to the fixed income or the equity within your portfolio, that is when you start moving away. So, understanding what that is. So, historically, as Bronwen alluded to, cash did deliver a real return which is outperforming inflation. In the last few years, this has probably not been the case, we currently sit in a situation of globally high inflation, interest rates were at historic lows, as much as we are now in a cycle where interest rates are increasing, people are still eroding that purchasing power. So, if you want to build it up, you cannot look at cash in isolation and say, yes, that is going to protect my capital.  You need to then maybe start adding some risk elements, which does introduce some volatility, it introduces some capital risk. If you add that into the equation, hopefully, it boosts your overall return that then you can still protect the purchase power that you have relative to kind of inflationary concerns that are prevalent.

Ayabonga Cawe: I like the point that you made that, I guess, cash is in many ways the starting point of any investment journey, because I want us just to think, Glen, for a second, about the role that cash can play alongside other asset classes, in what we are often told, should be a diversified portfolio.

Glen Copans: I mean, I think, you can look at it as the starting point of where you start with your risk-free element, and as you start creating risk, depending on your needs you start adding other assets, but from the same perspective it can also be, in times of stress, and it is obviously extremely difficult to call the markets and timing of when markets are going to underperform, but obviously if you can protect capital, if you are a conservative investor, that does not want that volatility, you probably need higher levels of cash, but you can also use cash as an opportunity, so, in times of uncertainty, rather than trying to say, well, I am going to figure out where I am going to put my money, sometimes it is not the worst place to be, to remain in cash type investments, and wait for that opportunity until you can actually get more comfortable from a risk profile, or from an opportunity of markets. So, cash does deliver that, but I think one needs to be cognisant of what the consequences are of that. If you sit with too long a period of time, just sitting in cash, we spoke about the ability to erode against inflation, to not meet your objectives, when do you actually potentially time to actually enter into these alternatives? But you can have the accessibility to ultimately get into the opportunities at points in time in the cycle that maybe do make sense.

[0:10:47] Cash and life stage

Ayabonga Cawe: Bron, I mean, I think just another thing that comes to mind, as Glen was speaking there, is this interface between risk preference and one’s life stage and by implication, their need for cash. So, I potentially at this stage in my life, probably need a lot less by way of predictable income streams, than say, somebody who, like my grandmother is in her 70s, has retired and effectively, I guess, is looking for a very predictable kind of lifestyle. What role does cash play there?

Bronwen Trower: 100%, I think a couple of my friends in sort of the age group, let’s call it 25 to 35, so we do not leave anyone out, we have always chatted about, and the starting point really comes from budgeting.  So, we are taking the scenic route, but we start talking about budgeting and going, okay, these are expensive, how much are you guys spending on groceries, what is the story, and then next level of budgeting is kind of going, how much cash do you hold and what do you hold it for and we are often throwing around a couple of ideas. Now, we are a diverse group of friends and we come from very different backgrounds so we figure out that there is kind of these sort of three elements to why we hold cash. It is our lifestyle, I think, it is a life event driven type thing, and it is the rainy day when we’re kind of the adults and really look after ourselves. So, the lifestyle type thing is, sometimes we find in our group of friends, literally going from people in marketing, psychologists, accounting, literally across the spectrum, is people want to save to enjoy themselves. They want to go on holidays, they want to do certain things in terms of maybe saving through to 6 months of their salary or on expenses to make sure that they have flexibility should they move jobs, should they want to do something, so there really is that lifestyle element. The life event element we found is, a lot of us that are in it, some people maybe are looking to get married, so engagement ring, wedding, those types of situations.  Some people care if they are turning a certain number, 50, 60 years old, they might want to save for sort of a gift or a present for the family.  Sometimes there is lobola saving, so we find that it depends on that life event that people might be saving for that might sort of trickle through. And then it is the rainy day, the geyser breaks, you have got to replace a tire or maybe just hopefully this does not happen, but you are in an accident of sorts and you have got to pay that insurance excess. It is that kind of stuff that we generally, I find, our age group when we have conversations about it, starting with budgeting, and then going how much cash do you have, what do you hold it for? And those examples I just mentioned are generally what the use is for in the younger professionals.

Ayabonga Cawe: It seems, Glen, it is a combination of lifestyle, preferences, needs, and of course also, I guess, risk management, because a lot of what you have mentioned there, Bronwen, is around saying, look, God forbid if you were to have an accident, or if you would have an unforeseen event that might require you to pay down money, you should have some of that on hand or able to unlock it quickly enough to be able to meet that preference. Glen, your thoughts on that?

Glen Copans: Yes, look, I mean, I 100% agree, those are the kind of core components, and I don’t think those go away as your life stage progresses. I think that goal orientated need does change quite significantly. You may have different needs in terms of family, approaching retirement, maybe saving for holidays too. So, those sorts of elements are certainly continued as you move along, but I think what tends to happen from a risk perspective is, it depends where you are in that sort of life cycle. If you are in that accumulation stage where you are hopefully building, you potentially have the ability to take on more capital growth, so you still need cash investments from a liquidity perspective, but the profile that you tend to have as you start approaching retirement, is obviously you start de-risking your portfolio, because you want to ensure that you have longevity, you have liabilities that you are going to need to meet and as you move along, you are ultimately going to try and find the components that you are able to retire without too much capital volatility. You tend to increase your cash components, but there are other considerations that you need to have, hopefully, you have got to that point, you have from a… you need to consider tax effects of what having cash is. So, from the SARS and the taxman’s perspective, we get a certain amount of rebate before you have to pay tax, but beyond that, tax does become quite penal from an investment perspective relative to equities. So, if you are in a higher earning marginal tax bracket, you do need to consider how much cash you need to have on hand and what are those needs.  Potentially there are other avenues that you can still find investments that maintain those sorts of characteristics that we spoke about before, the capital preservation, the low risk, the low volatility, the predictability. So, they are still in this kind of cash spectrum, but you look at it more as long term, maybe I need to pay off certain… or I want to put down a deposit for a house, or what the case might be. So, your objectives may change, but kind of the essence of it actually is potentially enduring all the way through, but your cash component certainly becomes more and more prevalent. I think it is an interesting dynamic here, cash is probably kind in the early years, because you have lower access to savings and you are spending all the money in your earlier years, and as you get later on, it brings a lot more relevance to the table unless you have sufficient capital at stake. You will always need cash available for whatever those purposes may be.

[0:16:41] The expanding definition of cash

Ayabonga Cawe: And I guess the purposes vary. You might want to go to Anfield, Glen, or Bronwen, as she said she might want to go on a trip somewhere, but I mean, Bronwen, you made a point earlier on which I found quite interesting, that the story of course starts in the budgeting and the allocative side of things, because that then determines your liquidity preference and your needs day to day of cash and whatever cash you hold. I mean, just in terms of what we are seeing insofar as other things that play the same function as cash, but substitute away from cash. I mean, I am thinking of loyalty programmes here, I am thinking of other alternatives, which effectively expand what we think of that cash basket as.

Bronwen Trower: 100%. I have got a couple of friends, those loyalty programmes, that if we do something, they go, can we please use our loyalty cards? So, it definitely, I think, adds an extra element, and what is interesting is though we are talking about budgeting and we are talking about saving and we are talking about cash, there is an element of spending. So, it is a little bit strange, but you can spend to earn the things that will help you get a near cash something that you can use for something that was already in your budget as returned.  So, I think there is definitely a place for it. I think more and more so as the years go by and as these things get more integrated within our banking offerings, there is definitely a place for something like that. However, I always do tell my friends that try and use their loyalty cards, do not bank on your loyalty cards, or do not bank on those loyalty points. Again, the starting point is that should be a bonus and if should that come and cover what your cash saving was, then it is a great, it is an extra thing, it is a bonus. And, I think, to add onto what Glen kind of said is, I do find in our age category there is no in between. It is this minimum cash portion in savings, and then it is the risky assets. There is no real in-between because as soon as you budgeted and you have got that minimum amount that allows you to basically feel a little bit comfortable, sleep at night, meet your objectives and your needs, then everything else tends to trickle into this long-term equity bucket, because we have time, because we can stomach the volatility and because we should be in the longer process.

[0:18:48] The growth of income funds

Ayabonga Cawe: And I guess it comes back to the life stage issue, Glen, as well, because circumstances change, people change, the dynamic and even one’s cash requirements every single day change. For many of the people who are listening in to this, I mean, there might be the question of saying, am I carrying too much cash around, and if I am, what are the other possibilities that can at least give me some medium-level kind risk rather than taking all of that money and ploughing it into equities?

Glen Copans: Yes, look it is… unfortunately it is hard to get kind of a generic overview of what is right. Every person’s individual circumstances, their life stage, their liquidity needs, exactly what you said, their risk profile, that is all going to determine how you should construct the person’s portfolio. So, two people that could invariably look identical in the same situation, may have different needs and it may be short-term needs versus long-term needs. So, as you said, I want to save to go to Anfield, but no, my mate, he has absolutely no interest in doing that. So, I might have a need to make sure that I have sufficient cash to actually do that. So, there has been, from an investment perspective, there has been a really large influx into what we call income funds, in the last kind of five to six years. It has been probably the fastest growing sector in the collective investment scheme, which is the unit trust industry. And basically, it comes from the rationale, we go back to those same characteristics of what people want, but it is giving them the ability to, at a slightly higher return. So, in some instances there are portfolios that are tax efficient, so they take care of that, they consider the after-tax nature, but invariably these are… they provide an income, they are stable, they are predictable and they tend to be liquid. And we don’t think that is going away, that is certainly going to continue to be a fast-growing component of the investment market. So, including those types of vehicles in there, you give it to a professional money manager, who has the ability to access all different types of banking products that allow you to get an enhanced return, but allow you to still get a good income return for yourselves. I think that is probably a core component that is going to remain important in investors’ portfolios.

Ayabonga Cawe: Are we finding, Glen, that those options are becoming a lot more open to the mass market insofar as the barriers to accessing, for instance, a unit trust, as a collective investment as opposed to maybe say 15, 20 years ago?

Glen Copans: Yes, it most certainly is, I mean, I think it is … there may have been some sort of aspirational or exclusivity thing that people felt they could not necessarily get into. There are so many different product providers that people have access to.  It does not matter what your income level is, what your geographic location is, what your preference is. And a lot of those minimums have been brought down to try and actually get people into the system and there are platforms there across the board that even will take one of the most complex instruments that were effectively the domain of high net worths only, that is now giving access to the traditional retail client, the man on the street. And it is about growing with a client, because someone at the age of 25, it is about teaching them the fundamentals of investing, getting them to understand, we speak about the, not having access to savings, but it is more about the concept and the process and getting that there, then the pure Rands and cents of what you get. So, getting people into the market, hopefully becomes this kind of long-standing relationship. When people eventually do get to the accumulation and growth stage of their lives, when they potentially do have a bit more capital to allocate. So, at least you can get a lot more of that education in the younger years now.

[0:22:55] Corporates and cash

Bronwen Trower: And if I can jump in, Ayabonga, sorry about that. Glen speaks about the high net worths only having these… access to these types of things, and now you are coming back to the retail client. I think what, Glen you and I have both seen this, where now your corporate clients also has a different view on cash. So, before they used to be very strict, treasury only, these big corporates used to say, do not even mess with my cash balance, I am going to go into the really safe stuff, so the stuff we spoke about initially, the deposits, the notice deposits and maybe money market, because that is still taking an underlying bank risk. And now what we have seen is, in these sort of structures, or in these offerings, these near cash offerings, we have seen that because corporates can still take sort of an enhanced cash position, but they are maybe earning dividend, say for example, which for them is, not only beneficial in the sense that you still have a liquid asset, the underlying still gives you a steady return, but now if you are earning a dividend as an SA company or corporate, you do not get taxed on that. And then we have seen the other way around, from where Glen was talking now about these income products that they take a little bit more risk, so, you are not out of the capital protection world. You earn a little bit more interest really, but now as a corporate again, where you started out, so we get entrepreneurs who started out companies, they maybe have not made these profits in the first couple of years, but they have these as, not just on balance sheet, they are now earning interest where they are not paying tax on that, so that is tapered off. So, we have found that people have gotten quite clever [hey, again with these hot tax solutions, not only moving from the client being high net worth to the man on the street, but also that the corporates are being able to access a wider range of cash or cash enhance products.

Ayabonga Cawe: Yes. And maybe just as, Glen, come in there before we wrap up, because I want us to maybe come back to the macro story and Bronwen and her mom and the decision-making matrix around the notice deposit, but Glen come in there.

Glen Copans: Yes, just from the corporates, I think what is interesting in times of stress and difficulty in the macro environment that we have had globally. Corporates tend to hold onto their cash. There is lack of investment, there is lack of capital expenditure, depending on the type of industry they are in, but what you find is we have seen a massive disperser, yes, unfortunately, there has been a big fall off of entities that have struggled, but the ones that have endured and been successful, have actually done really well in this kind of post-COVID world and this difficult macro environment and historically they would not have really thought of cash. It is an entrepreneur, they are very focussed on their business, now they potentially have larger cash pools and the ability to earn a little bit more by maybe looking and understanding a bit, or seeking the advice of a professional to assist with that, allows them say well, I can actually build up my capital balance, I can maintain it and I can use it at the point that I need without just leaving it in a call account earning absolutely no return. Now it is becoming a requirement that the CFOs of these businesses need to upskill themselves and understand what it is, because cash is not just for the retail investor, it has got a very important component for corporates and it is not just the domain of the large corporates as historically were done, it is now very much in the space of the SME market.

[0:26:20] Money market investments in a rising interest rate environment

Ayabonga Cawe: And I guess we are likely to expect a lot more of that with the part that interest rates are taking globally, where the benefit of maybe putting that in a sort of short-term money market or notice type instrument might yield some benefit as well, Glen and then Bronwen?

Glen Copans: Yes, that is 100% correct. I mean I think just the optics of what it looks like when, in post-COVID we had in excess of 300 basis point reduction on interest rates. And when the rates were so low, someone looks at their return and they might be getting 4% on a money market fund and if they actually take tax off for their own individual corporate it is even less. So, and in a rising interest rate environment, it moves lockstep and barrel with that, but now, fundamentally it makes a bit more sense, you are getting back to that point where, just the absolute level is more enticing, 6, 7%. We all say you are going to increase from here and also goes back to… you are now potentially going back into that realm where historically where money market or cash investments earned a real return above inflation. We are definitely going back into that cycle, so, it does lead itself more towards it being more enticing, but that is also coupled with the risk elements that we have. So, in an uncertain world, risk assets such as equities are certainly more volatile, so, people that are more hesitant that have a little bit more of shorter to medium-term investment horizon are probably going to look to cash-type investments as more appropriate vehicles for them to manage through this volatility.

Bronwen Trower: Exactly. This increasing rate environment, just to bring it back to my mom’s story, is exactly why I am getting more WhatsApps from her, because she is getting more notifications on products that look a lot more appetising than what she has seen sort of two years ago. So, often I am saying to my friends who aren’t in finance, who kind of go, what is happening here, we increasing rates and we are stifled and we are under pressure, and our expenses and our car payments and our bond payments are more expensive, but exactly to Glen’s tune is that this is a way to increase those rates so that we actually earn a return that is higher than inflation to protect that cash basket.

[0:28:35] Is it still worth carrying cash around?

Ayabonga Cawe: Bronwen and Glen just out of interest, I hope you have your wallets close by, I just want to find out like, on a liquidity preference perspective, how much cash are you guys walking around with?

Bronwen Trower: Glen has got enough to take him to Anfield.

Ayabonga Cawe: I do not want to mug you or anything, I just want to find out, I mean, how much do the people in the money markets carry in their wallets?

Glen Copans: That is a great question, so, my cash is invested, all my cash is electronic.

Ayabonga Cawe: Plastic cash.

Glen Copans: It has become a standing discussion now of how little cash you carry and unfortunately in some of the day-to-day things where you hop around town, where you actually need some form of cash. So, I was at an event yesterday where I used my last two notes of cash, and I actually was driving into the office this morning and realised I do not have one note of cash. So, it now means that I need to make a trip to an ATM to go and get cash and you will have to keep that, but it is certainly… I think we have moved into this world where cash is not necessarily notes anymore, but hopefully, more of the informal sector starts actually realising that we need to find ways. I mean an anecdotal thing, I was really impressed the other day, where part of the issue where you have people looking after your cars and you want to give someone the support. When I arrived at a… leaving a restaurant the other night, as soon as I got to the car, before I even said it, the guy says to me, don’t worry, I know you do not carry cash, I have got it sorted, I have got a machine. And there he was.

Ayabonga Cawe: Or a QR code?

Glen Copans: Yes, and that entrepreneurial spirit, I admire it, and you are probably going to get rewarded, so, firstly if anyone was using it as an excuse, they certainly now cannot use that, but now effectively I think that sort of ingenuity is definitely being rewarded a lot more. So, I admire that and hopefully, I think, we see a lot more of that in the South African market. We have definitely seen that actually in some other developing markets, but I think South Africa still has a way to go.

Ayabonga Cawe: Yes, Bronwen, last comment on your end, and I must say finding an ATM these days is like an Easter treasure hunt if, I can say so.

Bronwen Trower: No, I must agree with Glen, I had the same experience, and I was parking my car, I got back in the car, and the lady told me, do not worry, here is my number, you can do the whole send cash thing. And I thought to myself, this is exactly what we need. So, it is good to know that there is different forms of cash that are being adopted within our country.

Ayabonga Cawe: Awesome stuff. Glen and Bronwen, thanks to the pair of you for your time and yes, do tune in to the next episode in this series, where we will once again be in conversation with experts from Investec Wealth & Investment, and this time, we will be discussing private equity and how to invest in this asset class sensibly. So, do catch us then. Take care.

[00:04] Introduction and background to the new series

[02:25] ESG explained

[06:28] The importance of a long-term approach to sustainability

[10:00] How companies do the right thing

[13:27] How investors can mitigate harm

[17:36] The role of the regulators

[20:28] Mobilising capital for sustainability

[21:39] Investec’s commitment to sustainability

[23:54] A conscious approach to investing

[27:00] Closing remarks

[0:00:04] Introduction and background to the new series

Ayabonga Cawe: We are back with a new and engaging season of the Wealth Creation Podcast Series, brought to you by Investec Wealth and Investment. It’s a series where we bring you insights from Investec’s community of investment professionals and discuss everything you as a potential investor need to know as you embark on your wealth creation journey.

You will recall that in the first season of the series we introduced you to the basics of investing, concepts such as the global market and the importance of diversifying your portfolio; we also unpacked various asset classes such as crypto currencies and NFTs. 

In this second season we go a bit deeper. We explore investment concepts such as taxes, fiduciary responsibilities, investing in private equity, trading and shares and we also include a discussion on technical indicators and risks relating to short-term trading. We will also look at issues of retirement and how to create intergenerational wealth. Now if you have missed any of the episodes from our first season, please make sure to catch up on Investec focus Radio.

Moving onto today’s episode, I am joined by Boipelo Rabothata and Barry Shamley and we will have a conversation about the ever-important topic of the history, impact investing and sustainability. 

Boipelo is an assistant portfolio manager and analyst working on the Investec Global Sustainable Equity Fund; she is also involved in ESG analysis of global companies focusing on stewardship through voting and engagement for all listed companies. She fell in love the ESG and Sustainability because she enjoys helping to create positive social change. She is also motivated to leave the earth better than she found it. Boipelo is also a life skills tutor at FLY, which stands for Fun Learning for Youth and is a part-time YouTuber focusing on financial content.

Barry, on the other hand, is an equity fund manager and manages the Investec Global Sustainable Equity Fund and the Investec BCI Dynamic Equity Fund. He is also a member of the South African Asset Allocation Committee and deeply involved in driving the integration of ESG into Investec’s broader investment process and philosophy.

[0:02:25] ESG explained

Ayabonga Cawe: To Barry and Boipelo, thank you so much for joining me and maybe Barry, let me start off with you; just out of interest, when we talk about ESG, what in essence are we talking about and what implication does it have in relation to how many of you in the markets would have ordinarily approached your tasks of allocating capital?

Barry Shamley: Thanks Ayabonga. I think ESG is a mystery for some people, probably just because it is an acronym and even when you do dig down and you say, well, it is environmental, social and governance, still that does not really mean a lot to people and that is because there are a lot of underlying metrics within those three pillars that we need to come to terms with as well. 

I think also crucial is that some metrics are relevant to some companies and others are not relevant to other companies. So that is a concept called ‘Materiality’ and you have got to understand what matters for a specific company versus another specific company, but really what has changed I would say is that investment managers are becoming far more sort of long-term focused in their thinking. In the past it has been very short-termist and really, we have just focused on financial metrics that matter in the short-term, but what has changed now is we are looking at other metrics and while they are not necessarily financial metrics, they are material and can impact the financial outcomes of a particular company in the long-term.

What it really boils to is it is a framework for analysis; helping understand what matters to a company and what may impact the valuation of the company in the longer term.

Ayabonga Cawe: Boipelo are you finding that a lot more of the discussions, not just among yourselves as investment professionals, but even from the ultimate owners of the capital you oversee, is requiring a lot more of this kind of focus, as Barry says, on a wider set of considerations than just typical above-average returns?

Boipelo Rabothata: You know, I hear your question and I agree with you and I think a lot of people are asking themselves, do we sacrifice returns by investing in sustainable funds, if we start to look at ESG factors? Firstly there are distinct and different approaches to sustainable investing. These approaches are completely different in their goals and strategies and the effects they have on the real outcomes and also I think that many people still equate sustainable investing with its predecessor, social responsible investing, and they believe that adhering to its principles means sacrificing some financial return in order to make or change the world to make it a better place. But that is not the case, and there have been a couple of reputable studies that have been done to support the thesis that high sustainability companies significantly outperform their counterparts over the long-term. There is a guy from Harvard Business School and his colleagues who did two great studies to support this and additionally, in 2018 the Bank of America-Merrill Lynch found that companies with a better ESG record than their peers produce higher returns, and these companies are more likely to become high quality stocks or were less likely to have large priced declined. 

So I do think it is important that we start looking above just financial returns into ESGs because there are studies that support that you can benefit from both.

Ayabonga Cawe: Yes, and Boipelo what kind of things would we be looking at here; is it just about not investing in tobacco stocks or not investing in people who continue to generate their energy in dirty ways or what is it?

Boipelo Rabothata: Yes, I think a good start would be obviously there is an organisation named the Sustainability Accounting Standard Board, better known as SASB, that has identified material ESG issues for all 77 industries and ESG materiality refers to whether or not a piece of information is relevant and important to a company’s environmental, social governance reporting. These are material issues that are reasonably likely to impact the financial condition or operating performance of a company and therefore are most important to investors. Some ESG issues might be material in a specific industry, for example, water stress can disrupt operations of a mining or beverage company which rely on clean water in their production process, but not for other sectors like a bank. 

So investors now look for evidence that their portfolio of companies are focused on the material ESG issues that matter for financial performance rather than some ill-defined commitment to sustainability.

[0:06:28] The importance of a long-term approach to sustainability

Ayabonga Cawe: Now, I guess in scope and conception Barry, as I bring you in here, a lot of this and even the focus on sustainability is a long-term undertaking. I mean it is not the kind of thing you just think about from quarter to quarter. And I seldom hear investment professionals and people or analysts in the market and so on, think beyond just I guess a particular day’s performance or even a quarterly performance insofar as some of our underlying assets are concerned. What is your thought on this and does this challenge the industry to take a much longer term view?

Barry Shamley: Yes, I think it certainly does and I think it is about time. I think what we have seen, certainly in the past few years as we mentioned earlier, this intense focus on short-term improvements in return on capital, but that has often been at the expense of Capex that is required for longer-term growth. So there are companies that need to be investing in things that ensure their sustainability in the long term, but because they wanted to maximise profitability they have just looked to cut costs everywhere and ensure they can pay out as much earnings and distribute as much dividends as possible in the short-term and improve their returns above their cost of capital. But that does not work for a long time. It works until your existing assets are depleted or they run down and then you need to start investing in things like renewable energy or any processes that use less water or even in your labour force, ensuring that your L&D spend, your education spend on your staff is sufficient to keep them happy, motivated and progressing in their careers. 

So even with that commitment to Net Zero in 2050, that is a long-term commitment and companies cannot spend that money overnight. It has got to be budgeted accordingly and they have got to adjust. I mean obviously the more they do, the sooner the better, but it is a lot of money that needs to be spent and it needs to be carefully considered and budgeted for over the long-term. Yes, while there may be an impact on short-term returns, it ensures the long-term sustainability of the company and it makes sure it is well positioned going forward.

Ayabonga Cawe: Is it also changing, Barry, the tenure of the discussion in AGM’s, at a board level in some of the committees that we see there, in all of the sides of decision-making around distributional issues as you have said, so do you reinvest in CapEx or do you save some of that money, cut costs, buy back shares, pay dividends and so on and right through to the broader operational decision-making; are we finding that we are hearing a lot more and seeing a lot more even in the integrated reports of some of the companies you invest in, but also some of the companies whose performance you analyse?

Barry Shamley: Yes absolutely, so in the larger companies a lot of them have been providing sustainability reports for a large period of time. More recently, we are starting to see ESG metrics getting incorporated into exec remuneration and then obviously incentives drive outcomes, so a lot of the exec are now focusing and saying well how can I improve my ESG risk score, how can I ensure that my investors are comfortable with me? We have seen a lot of AGMs where resolutions have been put forward for sort of, I wouldn’t say aggressive adjustments, but investors want progress and if a company is not progressing at the right pace, investors are certainly becoming a lot more activist about it and trying to force change, either through voting against resolutions, proposing their own resolutions or in some cases voting to remove directors that are not doing the right things in terms of what they think is needed.

[0:10:00] How companies do the right thing

Ayabonga Cawe: And I guess Boipelo if I bring you back in to this discussion, you made a very important point earlier on when you said a lot of us see ESG within the scope of its predecessor, which is socially responsible investment and I remember at some stage there was an entire industry and eco-system on responsible investing, UN compacts and so on and one would be interested I guess for yourselves, where ESG would fit in not only complementing other people’s ESG efforts, but also I mean any other practical examples that you could share about companies that have done it quite well and maybe some who have probably come late to the party or have not done it as well?

Boipelo Rabothata: Yes, I think there are a couple of really great companies that are at the forefront of sustainability and who can think through wind, solar, mining, nuclear, hydrogen, carbon capture and all these other things. Within those badges of sustainability or transition rather, there are a couple of good companies internationally, because I have been working on the global stocks, for example, in the wind category there is a Vestas, in the solar there is Solar Edge and in hydrogen there is series and Air Products and there are companies that fall under the portion that is called ‘Adaptation’ whereas your Mondi’s or your impact from a South African perspective who collect and recycle cardboards and plastics, etcetera, so there is a grade of really great international companies, and I think on a social level (because that is more environmental) there’s healthcare companies like Novartis who are doing great things with access to healthcare and there are really good examples.

Ayabonga Cawe: Yes and you know Barry, I mean I never thought I would hear people in the capital markets talk about the circular economy, but if one looks at announcements that have come through from companies, anywhere from mining companies to those that work in packaging, talking about this notion of reuse of materials, of products, rather than scrapping them and then extracting new products from the environment and so on, is becoming a much, much bigger part of even the operational focus, let alone where capital is allocated. 

Barry Shamley: Yes I think it is almost an evolution of sustainability, so I think part one was maybe ESG, part two, was sustainability and then we are now moving into a sort of regeneration you referred to, it is Sustainable Development Goal 12, which is responsible consumption and production and that talks to the circular economy. It is about driving waste out of the process, examples of that would be like in fast fashion. I mean people buying an item of clothing that they wear once, for one season and then they discard it and I mean Boipelo was actually showing me today how intense the fashion industry is in terms of water consumption. 

So I think it is all about trying to make products that last a long time, when their use is over they can be recycled and find form in a new product down the line and I think all companies are considering that now because ultimately our resources are limited and even just considering the renewable energy transition, it is very commodity intensive and while we need a lot more mines to be developed, I think we also need to get to the point where we are recycling a lot of these metals to be used again. They cannot just be discarded.

[0:13:27] How investors can mitigate harm

Ayabonga Cawe: And I guess for me that brings me to something else which I would love to hear your thoughts on, if indeed we accept and maybe you must share with me your thoughts on this Boipelo and Barry, that all of these activities, be it how we allocate capital or how we use our materials and firm and household level and how we consume, we do all of those things differently. Can we really mitigate the harm that has been wrought on our environment and our societies by our current paradigm or are we just chasing a moving target here. Maybe Boipelo your thoughts, I mean can we really change the world positively here, save the planet, rebuild and reconstruct our communities on a different basis, build back or build forward better, as people often say?

Boipelo Rabothata: Yes, I think this is a very tricky one. Investor impact and company impact can often be confused and if we think about what impact is, this is the change that investors cause above what would have happened anyhow. So having impact means that an action, in this case OCO Investment, results in real change, for example reducing greenhouse emissions, whereas as a company’s impact is the effect the company’s activities have on people and the planet, for example, by selling a product that reduces emissions. 

So I think therefore as an investor, a way of affecting change through investing is either by becoming an active shareholder or using your voice as a shareholder to convince companies to improve their business practices or invest in funds that use engagement as a part of their broader sustainable investing strategy. So engagement is a way for investors to drive incremental positive impact or investors can alternatively encourage change by excluding companies that breach worldly accepted norms, right, like that is just an exclusionary type of investor. 

So investors can play some role in solving social problems in general and sustainability problems, to be specific, they can challenge also asset managers to use their muscle to deliver change, I think that is a way you can impact.

Ayabonga Cawe: I mean I like this idea that you can use how incentives are configured as a way to achieve incremental change. I mean a few years ago probably what people thought of when they heard activist investor was probably the person of Theo Botha, right, who raised certain issues about how companies are run and the impact that that would have on multiple stakeholders. It seems now it is more widely accepted, this notion of a triple bottom line, and I would like to hear from you, I mean if this is the kind of thing we want to encourage, from a regulatory perspective, what do we do and what are some of the things that are already being done and maybe what is missing in some of the sort of policy mix that has been proposed thus far?

Barry Shamley: Well, I think the most important starting point as an investor is to insist on disclosure from the companies that you are investing in, so that has happened to a large extent already. I would say a large proportion of companies are providing disclosure, as an example of that would be CDP, the Climate Disclosure Project, they have tens of thousands of companies that disclose in terms of the questionnaire that they ... so it is a voluntary questionnaire that you do, but we were part of that programme, where we send a letter to these companies saying, look, we would like you to participate in the survey because without actually understanding your own carbon footprint, without understanding all these various metrics, these environmental, social and governance metrics, you are not in a place to improve them, so that is the very first starting point.

Another interesting aspect is, I think the best returns you can make are finding the companies that are not doing this right, engaging with them and getting them on the right track, because it has been noted that as your ESG risk rating improves, so does your cost to capital reduce and your cost in debt. For activist investors, I think it is a fantastic opportunity to find those companies that are not behaving well, get them to disclose, help them. Once they have disclosed, they have a base to work from and then help them improve that base and they should be very willing and happy to do so because it is good for them, it is good for shareholders, it is good for management.

[0:17:36] The role of the regulators

Ayabonga Cawe: And on the part of the regulators? I think the point was made earlier on, in many ways you kind of have to shift the incentive mix, if firms feel they won’t be able to access capital markets on relatively favourable terms or on the same terms that they would now or in the future if they don’t make these changes, one would think that regulation plays the same role, that it fixes the incentives in a particular kind of way where you risk courting punitive sanction if you do certain things or if you don’t do certain things; what are we seeing insofar as that is concerned?

Barry Shamley: So it is moving at different paces in different jurisdictions. So Europe was definitely the leader with their EU Green Taxonomy and their Sustainable Finance Disclosure Reporting, the UK is following that, the US to a lesser extent. I know South Africa has been working on its own taxonomy as well, and I mean there are various regulations moving at a different pace in South Africa in terms of Reg 28. Pension Fund Trustees are required to determine whether the fund manager is in fact incorporating ESG in his or her strategy and then, if not, understand why not, because the default expectation is that you are and I think it is also, just a point to highlight, there is a difference between ESG and integration and sustainability. So to me, ESG integration is actually almost becoming the default now. I mean it does not preclude you from owning anything really, it just makes sure you account for all those risks in your valuation. Sustainability is more looking outward, like how is that company impacting the environment or society through what it produces or how it manages its own business?

Ultimately, it would be great if we could get to a level playing field around the world. Like I said people, different countries are moving at a different pace, but particularly with the environment, it affects all of us in all countries equally in a sense that, if we do not all work together towards it, if two countries decide they are not interested, it creates a big problem for the rest of the planet. So it is something that actually requires a cohesive response and something that I suppose someone like the United Nations would have to be quite involved in, in terms of making sure everyone is on side in terms of regulations and having similar outcomes. 

Having said that, we also do have to be considerate to [implement a] just transition in terms of emerging markets. Developed markets have had that benefit of cheap fossil fuels for many years, but on the other hand, I think a lot has been done already and a lot will be done in terms of driving finance or capital flows to emerging markets to help them perhaps even leapfrog some of the developed markets in getting ahead in that renewable transition. 

So I think we must embrace it; I know it is a bit like going into the unknown, but we have to be pragmatic and we have to be strategic and invest for the long-term.

[0:20:28] Mobilising capital for sustainability

Ayabonga Cawe: Yes, and it does seem Boipelo that I guess, the point is to make sure that all of those activities that contribute to favourable ESG outcomes are not starved of any capital; are you finding that alongside yourselves, I mean as global investors out at Investec, that there are others that are coming to the party, philanthropic capital or DFI capital and so on, that are effectively pooling capital for these environmental, social and governance-focused projects or a pipeline of projects insofar as that is concerned?

Boipelo Rabothata: Yes, so obviously there has been a huge pool of funds towards sustainable investing in the last couple of years. And I think as Barry has spoken, as the regulation increases and people are forced to adhere, it is going to pull a lot more people to start thinking, how do we incorporate this and which funds that are sustainable can we look at? And I think that will pull funds into sustainable investing as a theme and I do think that will probably continue increasing as time goes on.

[0:21:39] Investec’s commitment to sustainability

Ayabonga Cawe: And Barry, I mean one of the things we have not spoken about, many consumers are a lot more conscious of who they interact with, who they transact with and whether or not those people are as sensitive to the ecological, social and governance related issues that we have been talking about. From an Investec perspective, I mean what is that you offer insofar as that is concerned?

Barry Shamley: So I think just as an organisation I think it is important to note that Investec has for probably two decades been very serious and embraced sustainability wholeheartedly; I think we were very early to the party and I would say if you looked at us compared to our peers in the banking industry, both locally and in the UK, you would see that I think we do rate best in terms of our sustainability as an organisation as a whole. 

There have been a number of developments probably in the last two or three years in terms of our product offerings; the one is the Investec Global Sustainable Equity Fund, the other is green bonds and sustainability-linked loans that Investec has issued to the market and then there are a number of other initiatives that we are looking at. I know the bank has made a small investment in an impact fund that works with the export credit agencies to help sustainable development on the African continent. 

So I think what is key for us I think as a bank we know that this is a key focus for us and I think over the next couple of years, I think you will just see more and more offerings. I think that in our banking operation we have tried to encourage our banking clients to understand their carbon footprint and probably the most important thing I think we are doing, is education. So we are trying our utmost to ensure that people understand the risks; there is a phrase I use, ‘wilful blindness’. It is a legal term; it is really people actually sometimes just don’t want to know what the problems are because they do not have to deal with them, so through our Road to 2030 campaign and our Class of 2030 education campaign, we are trying to help our clients and our staff understand this so that they can change their ways, can potentially change their investments and can change the planet in the long-term and as I said, I think it all starts with education.

[0:23:54] A conscious approach to investing

Ayabonga Cawe: And I guess that is the important part. Because at the end of the day, it is not just about educating the management teams, educating the investment community or even educating all of those who represent the owners of capital, but from a consumer perspective I mean I am quite interested, Boipelo and Barry as well, whether or not some of the areas of ESG, I mean if you take the social one, you know, are we interested as consumers in the labour processes that give rise to the products that we consume or interact with every single day, are we interested in where the food that we consume comes from or the metals; Barry was saying earlier on, a big part of the green shift that is happening is very, very resource intensive. Are we bothered about where some of those resources come from, be they in our smart phones or even in some of the devices that we use Barry, or do we have some of that ‘wilful ignorance’ that you were talking about?

Barry Shamley: Yes, so I think that is something that is increasingly happening, I think particularly with the millennial generation: they are more conscious of where things come from, how things are made. I think it is probably less so with the older generation but I think that is part of our job in terms of this education, is understanding supply chains, understanding that well maybe something is cheaper but that you are importing from overseas, but it may be from a country that does not respect human rights and you could be actually creating jobs in your own country and those items then would be affordable. 

I think we are getting there. I think there are certain generations that are more advanced in it, but I think hopefully through this education process, people will start asking those questions more and you will probably find. I think I saw something today, where people will start labelling even their food in terms of the carbon intensity of food, understanding that piece of meat that you eat, just understanding carbon intensity in various products I think is going to increase.

Ayabonga Cawe: Yes, Boipelo any thoughts on that one?

Boipelo Rabothata: Yes, I was going to say I am actually going to try make it personal. Look I am not vegan but I definitely do try to reduce my meat consumption and I think that is where it starts; it is being aware and starting to alter, before we call on companies to change; we also need to be making a change. I have reduced my meat consumptions where I have meat-free Monday, this is only if you try to impact the reduction of meat then as Barry has said, meat emissions from livestock are actually more damaging than emissions from transport. So methane, for example, is 28 times to 36 times more potent than carbon dioxide, so CO2, so I think it is just being aware of those things and then trying to see where you can balance it out and try change yourself.

Ayabonga Cawe: I must say, I mean I find whenever I do meatless Monday’s, that I sleep a tad better than when I have had a lot of meat in my diet, but also meat takes so much longer to cook, so there must also be a massive energy requirement there as well Boipelo.

Boipelo Rabothata: No that is true and yes, that is true.

[0:27:00] Closing remarks

Ayabonga Cawe: Maybe then Barry and Boipelo, just as we wrap up: I think for many of our listeners who are interested in what ESG approaches as a way of allocating capital and investing might mean for their portfolios, might mean for their consumption baskets, might mean for how they live and interact with the environment and the social context therein and how they govern firms and their lives. What message, just as we close, would we have? Boipelo I will start off with you and then get some perspective from Barry as well, on how we make sure that this change, not just in how we invest, is also translated into other changes that we make in our lives to change the world positively, save the planet and save our communities and build forward a bit better?

Boipelo Rabothata: Sure, I think I will just close off with a quote which is very relevant from Larry Fink, the CEO of BlackRock. He wrote to company CEOs at the beginning of 2018 and said that: “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.” And I think this quote is encouraging because it shows just how the world has come in making a shift. I think every generation has to fight for future generations and it is encouraging to see that this generation is starting to take, maximising stakeholder value instead of just shareholder value and taking sustainability in impact, investing variously. So it is encouraging to see the progress that has come from far and even us having this conversation, is good progress.

Ayabonga Cawe: Boipelo thank you very much, I never thought in my life that some of the big asset managers in the world would let go of their Friedmanite ideological origins, so I guess the world is a changing place and Barry, some of your closing reflections.

Barry Shamley: Yes, I think the point I would like to leave everyone with is: we are all saving for our retirement, for our kids, and what is the point of saving for that if the planet that we are going to live in, in 20- or 30-years’ time or 40 years’ time when we retire, is just a sort of plagued with unrest because of growing wealth, inequality, extreme climate change and extreme weather events. So it is really, like, invest in the future you are saving for, that is what I would like to say. It is no point investing money and then yes, you are very rich, but at what expense and how good is that money going to be when you get to that point in time and we carry on, on the same trajectory that we have been going on? That’s it.

Ayabonga Cawe: Barry and Boipelo, thank you to the pair of you for your time and so generously sharing of it and yes, folks, that was our first episode in this second season of our Wealth Creation Podcast Series, brought to you by Investec Wealth & Investment. Don’t miss our next episodes and if you have missed any of the episodes from the first season, please make sure to catch up on Investec Focus Radio. From myself your host, Ayabonga Cawe, until we meet again.