Jacobus Brink, head of investments at Novare Holdings, looks at how investors can use the rand’s gains this year to build a global ESG portfolio and benefit from an upsurge in demand for sustainable assets

The rand’s rally to a two-year high earlier this year was reason enough for investors to move more money abroad. Here is another incentive: While environmental, social and governance investments are all the hype, sustainable assets are still not fully priced for the long-term benefits they promise investors, or our planet.

As one of the world’s most volatile currencies, the rand tends to overshoot whether strengthening or weakening. So, it was no surprise that the currency’s march to below 14/$ in mid-May only held for about a month.

South Africa’s relatively high levels of inflation and interest rates compared with that of our major trading partners, structurally lower economic output, power shortages, and the fiscal risks associated with the government’s unsustainable debt levels all limit further gains. The nation’s slow vaccine rollout also threatens to weigh on the currency at a time when markets are speculating on when the U.S. Federal Reserve will raise interest rates.

Building an offshore portfolio, however, should not only be about timing the rand’s ups and downs, and any potential weakness in the currency should be considered a bonus rather than an outright objective of investing abroad.

Currencies are notoriously difficult to predict. Domestic investors have made a habit of rushing overseas after things have already gone south for the rand, instead of using opportunities like the one presented in late May and early June to buy into the currency’s strength.

At the current level of around 14.90/$, the rand is much stronger than it was a year ago, when it was hovering nearer to 17. The currency is at similar levels to those seen before the onset of the pandemic, providing an opening to allocate more capital to offshore opportunities.

Fallen Short

Locally, pressure is building on investors to consider ESG investments, both through legislation and clients demanding that their money generate a return while being used to fight issues such as climate change, social inequality, or unfair labour practises.

Yet, in South Africa, most sustainable investments are found in the private equity or debt space, and pension funds are permitted to only invest up to 10% of their assets in unlisted alternative investments. So, right now, the opportunity set is overwhelmingly internationally focused. One in four European funds classify themselves as sustainable and investors are being bombarded with different products and options, not all of which will deliver on their goals, so picking the right investment needs a thorough due diligence.

While there is a growing awareness among of the need to integrate ESG beyond just a box-ticking exercise, the implementation phase is where many investors fall short. This includes formulating a process or philosophy on your views of what constitutes sustainable investment, what does your due diligence look like, how are these investments going to be analysed and monitored, or how they will be included in your portfolios.

While we have had socially responsible investing as part of many mandates in the past, these tended to focus on corporate governance at companies rather than looking at how these investments are adding value within a fund’s broader portfolio, or the environment in which businesses operate. All these building blocks need to be put in place as the market develops locally, and more projects, particularly in renewable energy, start gaining traction.

The investment case for including ESG as a measurement when constructing a portfolio is compelling. The MSCI Emerging Market ESG Leaders Index has consistently outperformed its much larger MSCI EM counterpart since 2008. BlackRock, the world’s biggest investment manager, found that ESG-focused portfolios have been more resilient through the coronavirus crisis.

Big Inflows

According to Morningstar, inflows into sustainable open-end and exchange-traded funds in the US rose tenfold between 2018 and 2020, when they reached $51.1 billion. Globally, ESG assets could still swell 40% to $53 trillion 2025, according to Bloomberg Intelligence estimates.

At Novare, we took the view more than a decade ago to start investing in sustainable real estate, such as green buildings, or projects that are cognisant of their carbon emissions, in the hope of being able to extract the social-responsible premium out of them.

But it is only more recently that investors have shown a clear willingness to pay more for environmentally friendly financing initiatives, with green sovereign bonds in European countries such as Germany and Italy being issued at lower yields to their conventional debt. Fitch Ratings has highlighted that the premium being paid for green assets is increasingly becoming evident in market prices. Several African countries are also planning to issue green bonds this year as ESG factors feature more prominently in development programmes, Fitch has said.

Do not let the grass grow under your feet in the hope of profiting from further rand strength, demand for ESG assets is outpacing supply, with few signs of a slowdown. A survey by McKinsey last year found that 83% of executives expect ESG programs to contribute more to shareholder value in five years than today.

There are still many opportunities to get in on the ground floor.