Responsible Investing: Bringing non-financial capital to the table

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Investors should give equal focus to a company’s human, environmental and social capital, instead of just demanding returns and progress in the form of financial capital, says Panarchy Partners Pte Ltd founder and CEO Munib Madni.

He came to this realisation after working in the financial industry for more than two decades. Prior to founding the Singapore-based fund management company last year, his work experience included being chief investment officer for Asia and portfolio manager at Morgan Stanley Investment Management Inc and associate director at Aberdeen Standard Investments.

“I have been an investor for 25 years. I was trained to look purely at financial capital. It took me five to six years to evolve [into the investor I am]. I was taught my institutional clients, who would ask me questions about other forms of capital, such as human, social and environmental capital,” says Munib.

“I learnt this attending conferences and studying the topics. I also observed my children — the way they consume and the way they act. I did not want to leave the wrong kind of legacy.”

He recently gave a presentation on “The evolution of investing towards sustainable investing” at an event organised Malayan Banking Bhd and Bursa Malaysia Bhd called The Evolution of ESG Investing.

The word “panarchy” was coined Belgian writer Paul Émile de Puydt in 1860. It refers to a conceptual framework that accounts for the contrasting characteristics of complex systems, which are stability and change. Munib named his company Panarchy to express the complex relationship between humans, human-created systems and the environment.

Munib tells Personal Wealth on the sidelines of the event that he characterises investors who focus on all four forms of capital as “Panvestors” — a term he coined himself. In the next two decades, investments in companies that are bad for the environment, human health and society are going to be stranded, he says. “So how do I, as a traditional investor who has evolved into a ‘Panvestor’, help the bulk of investors, who are not trying to be activists, to become advocates of all forms of capital?

“[To do so] you can start focusing on the four forms of capital. Then, if you want to become an activist, you can completely exclude coal from your portfolio, for example.”

There is no dearth of companies that focus on the four forms of capital and also deliver financial returns, according to Munib. His investment team has identified more than 90 companies globally that meet these criteria, about 23 of which are currently in the company’s portfolio.

“For us, that was a clear sign that doing ‘good’ does not mean lower returns. I believe that in the next 15 years, sustainable companies will perform better because they will be better prepared when regulations [requiring them to adopt sustainable practices] come in. They will be better positioned to do damage control,” he says.

“These companies are leaders in their industry. They are setting standards for others to follow. If they are already ahead of the curve, their margins, sales and profitability will be better as well. I am convinced that sustainability, as a factor within investing, will lead to better financial returns.”

A company that values human capital is one that respects employees and values gender diversity and inclusion, for example. Social capital covers consumer protection, sustainable supply chain programmes and community initiatives. Meanwhile, environmental capital involves initiatives that protect natural resources, commitment to cut down greenhouse gas emissions and investments in renewable energy. Valuing financial capital means promoting sustainable financial growth.

To deepen his knowledge on non-financial capital, Munib is pursuing a master’s degree in environmental management at the National University of Singapore. He has also hired sustainability experts in addition to traditional financial analysts so they can go beyond just analysing balance sheets and income statements.

“I need to upgrade my skillset. As a ‘Panvestor’, I should know how to analyse CDP [carbon disclosure project] disclosures, GRI [Global Reporting Initiative] compliance and information flow from companies regarding environmental issues. I should know how to analyse that information as well as I know how to read balance sheets, income statements and cash flow statements,” says Munib.

 

Changing the investment process

In general, sustainability investors use several methods in their investing process. Many use negative screening, which excludes sectors deemed controversial. Positive screening seeks companies with positive environmental, social and governance (ESG) performance while ESG integration explicitly includes ESG factors in financial analysis.

What Panarchy starts with instead is performing a sustainability audit. The investment team analyses governance practices, country, sector and resilience. The only sectors they stay away from are gambling, tobacco and weapons. The process ends with financial analysis.

“I would argue that most other ESG or sustainability funds that are not new already have a process and strategy. So, they had to integrate or overlay ESG strategies. But we started with sustainability and equally respect all four forms of capital. We upended the traditional investment process, which normally starts with financial capital and ends with ESG integration,” says Munib.

Using these filters, could a fossil fuel company end up in its portfolio? It is possible, he says, but only if it meets certain criteria. “The benchmark for us to invest in a fossil fuel company is very high. There has to be a clear line in sight [in the company’s plans to] completely stop its fossil fuel capacity expansion and move into renewable energy, as opposed to just cutting down the percentage of fossil fuel production.”

Munib argues that the concept of governance should be extended. Traditionally, this has revolved around protecting the minority shareholders of companies. Now, it should include engagement with stakeholders, who do not just comprise financial shareholders.

Stakeholders include consumers, suppliers, regulators, employees and society, he points out. Companies have traditionally focused only on their financial shareholders. But that has to change now as the voices of the other stakeholders are getting louder.

“For example, in a previous case, shareholders did not care that a cosmetic company used animal testing. But its customers told the company that they did not want the company’s products to be tested on animals. The customers forced change on the company, which had to bear the cost of changing its practices. That is an old example of stakeholders taking actions that affected shareholders. We will see more of that,” says Munib.

He adds that this could happen when regulators and environmental activists push companies to change.

When Panarchy finds out that a portfolio company has some weaknesses, it will encourage the company to make changes. It opts for this method of engagement rather than directly selling the company’s shares.

“There is a company in our portfolio that does a lot of good things with its human, social and environmental capital. But it does not have a female member on its board of directors. We engage with them constantly to remind them that a female member is needed for diversity of opinions. The board cycle is usually three years. So, if they do not make a change then, we may have to exert force. But for now, we are advocates,” says Munib.

Another way he changes the investment process is altering how fund managers are incentivised. On his team, 50% of the fund managers’ performance fees goes to the Panarchy Foundation, which is run an independent board. Their fees are in line with the industry average. The staff gets to decide which charity the money is given to. The three areas that the foundation focuses on are children, animals and the earth.

“I truly believe that for sustainable investing to take off, even the investor incentive structures have to be rearranged. That arrangement gives my team a lot of passion because our incentives are beyond financial returns,” says Munib.

Panarchy is fairly strict when it looks for investee companies because it uses global standards to judge them. The investable universe is large enough for the company to do so, he admits.

“If you are running a pure Asean portfolio that is ESG compliant, you could not apply our standards. You may have to adjust your filters to fit the reality on the ground, where regulations are not as strict and standards are still evolving. But in a global context, we do not have a problem.”

 

Picking the best companies

Panarchy Partners Pte Ltd launched its first fund — the Global Panvest Fund — in April. It invests in the equities of global companies that demonstrate good progress in sustainability practices and also deliver good financial returns. The fund is open to accredited investors.

All the companies in its portfolio are expected to focus on the four forms of capital and generate financial returns, says Panarchy Partners founder and CEO Munib Madni. “If we can double our clients’ money in 7 to 10 years and give them progress in terms of human, social and environmental capital, we will have beaten most benchmarks in the longer term.”

About 35% of the fund’s portfolio is in the consumer staples space and includes companies such as Unilever plc and Danone SA, a French multinational food production company. Between 10% and 12% of the portfolio is in the financial space such as the Bank of Nova Scotia in Canada and Kasikornbank in Thailand.

Another 10% is in telecommunications. Norwegian multinational corporation Telenor ASA, which has invested heavily in products that promote financial inclusion, is one of its portfolio companies.

There are not many technology companies in the portfolio. One of them is KONE Oyj, a Finnish company in the lift and escalator industry. “It is an example of a company using old technology and modernising it to allow for seamless and environmentally friendly movement of people through travellators, escalators and lifts,” says Munib.