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How companies behave matters

It is not just about profits.

In the 1970s, Nobel prize-winning economist Milton Friedman famously noted that “there is one and only one social responsibility of a business – to use its resources and engage in activities designed to increase its profits”.

This quote is often cited as a rejection of the ideas behind responsible investing. If all that matters is a company’s profitability, there is no value in analysing how it scores on environmental, social and governance (ESG) issues.

However, the rest of this quote is often overlooked. Friedman added the caveat: “so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud”.

Even Friedman, therefore, recognised that how a company behaves matters. Maximising profits does not justify all means. And although Friedman himself may have disagreed, it doesn’t take much to extend that thinking to include much more than just avoiding deception and fraud.

Read: ‘Investment sector can drive better corporate behaviour’

“Times have changed,” says Allan Gray equity analyst Tim Acker. “Society’s view on investing and business has evolved. The social contract between companies and society has changed. Today most people would expect a company not to pollute, to treat its employees fairly, to contribute to its community. Being a responsible corporate citizen has become more important.”

The way a company behaves has also become increasingly important to investors. According to data from Morningstar, ESG funds attracted new inflows of $8.9 billion in the first six months of this year. That is a substantial increase from the $5.5 billion of inflows into these funds for the whole of 2018.

As Acker notes, this is not just about fuzzy ideas of doing social good. Responsible investing is about generating long-term, sustainable returns.

Businesses that exploit their workforce, destroy the resources they rely on, or are built on fraud are unsustainable.

Those that encourage productivity by looking after their workers while managing their resources responsibly and holding themselves to high standards of governance are more likely to generate superior returns for shareholders.

For Acker, there are four areas where this is impact can be clearly apparent for investors:


The potential profitability of some companies is very closely related to how they interact with society. In the South African context, Capitec is a good example.

“This is a lending business that lends at high interest rates – above 30% for many of its clients,” Acker explains. “It’s also an extremely profitable business. But the concept of sustainability is a key question when looking at the valuation of Capitec, because we have to ask ourselves how sustainable these high profits are over the long run.”

This, Acker explains, is based on a social question.

“When they lend money at high interest rates, arguably many borrowers are not getting a great deal,” he argues. “You could say that maybe this business is extracting more profit from society than the value that is added. So that creates a risk from a regulation point of view.”

The National Credit Regulator has already lowered the maximum interest rates that businesses like Capitec are allowed to charge, and may do so again in future. This limits its potential profitability.


Besides regulation in specific sectors such as the case with Capitec, there are moves in certain parts of the world, particularly Europe, to compel investors to consider ESG factors when making any investment. If this leads to them excluding certain kinds of assets from their portfolios, or favouring other assets, this would impact on how those assets are priced.

“The trend we are seeing is that these kinds of regulations are becoming more and more binding, and we would expect more of them to come to South Africa,” says Acker. “This actually affects how investors are behaving. It affects the assets they are buying and selling, and therefore affects the value of those assets.”

Social pressure

Related to this is that many large investors like sovereign wealth funds, endowments and big pension funds are even moving ahead of regulation and disinvesting from certain industries altogether. Coal mining is a good example.

“Some of the larger investors have said that we will not buy any coal mining assets, and we will sell out of our existing coal mining assets,” explains Acker. “This can create a scenario where you have stranded assets.”

In other words, if you buy shares in a coal mining company today, you might find that when you want to sell that asset in the future there are no buyers.

“So even if you don’t personally care about the issue, you have to think what the rest of the market is doing, and what is the rest of the market is going to think in five or 10 years’ time.”


The South African market has had plenty of experience of poor corporate governance in recent years. The most high profile was the lack of board oversight that allowed the Steinhoff fraud to perpetuate, but there are a number of other examples.

MTN, for instance, was hit with a substantial fine in Nigeria because the company failed to work appropriately with the regulator, accounting irregularities have surfaced at Tongaat Hulett, and at Old Mutual it appears that the board may have failed to follow proper process in dismissing CEO Peter Moyo.

In each instance, investors have suffered as these company share prices have come under pressure.

“Governance is not just a box-ticking exercise,” says Acker. “It’s clear that when you have a failure in governance, there are lots of ways that value can be destroyed for shareholders.”

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“You could say that maybe [Capitec] is extracting more profit from society than the value that is added. So that creates a risk from a regulation point of view.”

No sense of irony here, that AG is doing the same…?

Very appropriate article. And very well articulated.

Companies and partnerships whose existence depends on ripping off their clientele (and their employees) at every opportunity deserve to be regulated out of existence.

At the heart of these problems are the selfish, greedy behaviour of unethical individuals in leadership positions.

It’s regrettable, but no surprise at all, that the Financial Services industry is swamped with such individuals at both executive and board levels.

Regulation usually has the opposite effect as it prevents new entrants and entrenches the encumbants. If there are outrageous profits to be made this should attract competition driving down the profit margins. This is how free enterprise is meant to work.

Competition is a great thing.
But only when it works freely.

Too often, the ethically-challengeds’ first order of business is to behave in a cartel-like manner and collude on dishonest business practices to stifle this. Insurance claim rejections are a perfect example of this.

Let us analyse the egregious Capitec example. What happens when a company is profitable is that it invites competition. If Capitec is so profitable due to high interest loans, why don’t the other big four banks muscle in on its turf? Let the borrowers get a better deal at ABSA of FNB. This would only drive interest rates down. The fact that the don’t indicates that the risk- reward equation would be skewed in favour of risk. What is really happening is that Capitec is the only lender willing to take on the risk and get the required return. The question we should be asking is how we can get risky borrowers under market priced loans. The answer is one cannot. If the regime legislates interest rates, which they can do, all this will do is stop Capitec lending money to this sector. You can legislate interest rates, but cannot force lenders to lend. Interest rates and risk go hand in hand. One cannot interfere with market forces without adverse consequences. Bad example. Capitec is profitable because they gave the big four the middle finger when it comes to ripping off the public with bank charges. Interestingly enough Capitec does not pay over the odds when borrowing indicating that it is not perceived as risky.

Regulation is simply a market distortion by government fiat. An example would be South African bonds. Once SA is rated junk by Moody, a lot of funds will be forced to sell “for their own protection”. This will simply make SA bonds under-priced and over yielding. The market would ordinarily sort out the price but with the distortion they become a good investment that is only available to the few.

The concept of stranded assets is nonsensical. For a solvent coal mine there will always be a buyer- lets call them less scrupulous or less woke. It depends on the price. Of course. If one is not allowed to buy a coal mine either by legislation or social pressure, then coal mines will become cheap high yielding assets – and attractive at that. Anything but “stranded”. Again, this favours the few that are allowed there and penalises the ones with tied hands. In fact one of my best investment was Hwange at R0.05 about 20 years ago. My first 100 bagger! Wish I had got more.

Corporate governance goes back to Milton. What Steinhoff, Tongaat Hulett and MTN did was illegal. Old Mutt was probably not. Unfortunately one does not have the luxury of picking shares that may or may not be subject to these scandals. One is only wise in retrospect.

I find the Capitec example puzzling to say the least. Capitec has done more than any bank to drive down banking fees and provide greater access to banking services for the poor, something that even that old Communist fossil Jeremy Cronin pointed out when he highlighted that Capitec provides faster, friendlier and more efficient services than any Gov department or parastatal. That is before he launched into his motivation why the sate must own everything.

But back to AG blasting Capitec as an unscrupulous loan shark, apart from providing the poor with cheap transactional banking services, no other bank hasa been able to provide access to credit cheaper than Capitec. What puzzles me even more is that in nearly every presentation I have seen on socially responsible credit for poor consumers in emerging economies Grameen Bank from Bangladesh is touted as a shining example – yet Grameen Bank’s lending spread is multiples of Capitec’s lending spread.

Acker looks even more like a hypocrite if you consider some of AG’s largest holdings. Sasol, British American Tobacco and Glencore are hardly what I would view as socially responsible, sustainable investments…

Even Capitec features as an AG holding albeit small.

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