War, weapons and ESG investing
Morality: noun principles concerning the distinction between right and wrong or good and bad behaviour.
Ethics: noun moral principles that govern a person's behaviour or the conducting of an activity.
Weapon: noun a thing designed or used for inflicting bodily harm or physical damage
As the war in Ukraine continues, many people within the investment world have been speculating as to whether weapons can be justified within an environmental, social and governance (ESG) portfolio.
Investors often view defence as a ‘no-go area’, up there alongside tobacco or oil and gas. But, as governments increase defence spending, shares in defence-related companies have soared.
And there’s even suggestion from some quarters that these stocks could be unlikely, but legitimate, targets for investors interested in ESG.
So has war changed the rules on sustainable investing?
Not if we look at the real definition of ESG
The PRI – the world’s leading proponent of responsible investment – defines ESG integration as “The systematic and explicit inclusion by investment managers of ESG factors into financial analysis”.
In other words, there’s no such thing as an ‘ESG’ stock or a non-ESG’ stock – ESG is a form of analysis.
It’s used to identify investment opportunities that reduce damage to the environment (E), reduce social harm (S) and promote good governance (G).
The other important factor to consider is that ESG is about operations, not impact; it’s a way of analysing the social and environmental risks to a company, rather than the risks a particular company poses to the world.
In this context then, we can start to think more deeply about the place of weapons within an ESG portfolio.
There are a few other things to bear in mind:
1) We’re not talking about ‘controversial weapons’
Even as governments agree massive funding packages to help arm Ukraine against Russia, no one would seriously expect these shipments to include chemical or biological weapons. Similarly, most investors committed to sustainability would want to exclude these as well. SEB, for example, may have overturned its blanket ban, but still excludes any controversial arms, such as cluster bombs, land mines, or nuclear weapons.
2) How deep can you go anyway?
But this doesn’t mean ESG funds won’t contain anything defence related. Remember, ESG doesn’t necessarily equal ‘ethical investing’. The aim is investing your money as sustainably as possible, considering how companies are impacted by – and make an impact on – the world around them.
In any case, screening out any every company with defence interests would prove extremely difficult. For example, Microsoft generally ranks as a fairly low-risk ESG company, but as one of the world’s foremost tech firms, it’s involved with military and defence technology (including producing AR-enabled helmets for US soldiers for use in battle).
War in Ukraine impacts other areas too
Defence isn’t the only area where conflict in Eastern Europe is giving investors pause for thought.
Rising energy costs and the removal of Russian gas as a major supplier to Europe has seen some investors reappraise their holdings in oil and gas companies. Maintaining security of supply is becoming as important an issue as the focus on energy transition.
Meanwhile, the conflict raises questions over where the materials we need to produce clean energy will come from, particularly with the shift towards greater numbers of electric vehicles. Russia is the world’s fourth largest producer of nickel, an essential mineral for EV batteries, and is also home to many other metals that are vital to the 21st century economy.
What does this mean for sustainable funds?
Following the invasion by Russian forces back in February, some investors were prepared to put ESG on the backburner. According to Reuters, total assets under management in equity ESG funds were at US$3.2 trillion at the end of February, down 9.3% from the start of the year.
There’s a well-worn myth that sticking to your principles means a trade-off on your returns. There’s still plenty of evidence that following your conscience doesn’t mean having to compromise, but in periods of global uncertainty like this one, it’s inevitable that this viewpoint will come under pressure.
It’s true that the conflict has given investors plenty to think about – and it’s producing more questions than answers. In the long term though, principles still have a place in a portfolio. As ever, it calls for careful consideration of all ESG factors – and knowing how best to apply them.