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[The war in Ukraine has affected the ESG/Impact investing community in a number of major ways. First of all, through reduced investment inflows. The Institute of International Finance (IIF) reported that ESG funds saw inflows halve in Q1 2022 amidst Russia’s war in Ukraine, volatility in ESG-heavy tech shares, and higher oil prices diverting funds into non-ESG energy stocks. ESG Q1 fund flows of $75 billion were at their lowest level in seven quarters. IIF data also showed that flows into ESG bonds were also down sharply in Q1, dropping to $14 billion from $27 billion.
More importantly, Russian aggression has been fostering new intense debates on fundamental, socially responsible issues such as whether defense stocks should be allowable in ESG/Impact portfolios or, at least, no longer be considered unsuitable as part of a negative exclusion policy. Does Europe’s new geopolitical reality and use in defending democracies force reversals or adjustments to investment firm ESG and sustainability policies?
The war has also become a wake-up call for social investors that their efforts and investment focus not only reside on a sector level. It has also renewed the question of investing into countries like Russia with autocratic governments. According to Bloomberg, ESG funds had at least US$8.3 billion in Russia before the invasion; having invested in Gazprom PJSC, Lukoil PJSC and Rosneft, among others. About 14% of sustainable investment funds are directly exposed to Russia, according to industry research firm Morningstar Inc. Just like social investors did not want their money invested in South Africa during apartheid, will the brutality of the Russian invasion be a catalyst to new restrictions being applied globally to the most autocratic governments? Should social investors consider whether politics and international conflicts should, to some degree, guide their investment decisions?
On another front, while government sanctions and divestment by corporations have demonstrated the power of the capital markets and the commitment of major companies to operate consistent with core values, this raises other investment issues. The main question that reveals itself through this war time environment is How do you calibrate a company’s actions? How do you balance doing the right things like exiting their operations in Russia versus accepting the financial hit that the company took in exercising their social conscience? To what degree do you quantify and reward/punish the net effect of a company’s decision? There will be increased pressure for ESG/impact funds to explain their rationale behind investment decisions as social investors will be questioning whether the money they have put toward environmental, social and governance goals is being well spent.
To dig deeper and get a better understanding of what is happening in the rapidly evolving social investment environment, the Institute for Innovation Development decided to reach out again to a cross-section of socially responsive asset managers – from ESG to impact to focused thematic strategies – and get their real-world, in-the-trenches perspectives and thought leadership on these issues. We would like to thank Ultimus Fund Solutions – one of the largest independent fund administrators – who provided introductions to some of their socially responsive asset manager clients and that has created investment vehicles for all of them to enable more access for investors to socially driven investment options.
Let me introduce you to our panel and then we will jump into getting a true lay of the land on these vital issues from the following experts in this field:
Andrea Dalton, CFA, Portfolio Manager & Kristin Hull, Ph.D., Founder, CEO & CIO, Nia Impact Capital Capital, an asset management firm that invests at the intersection of social justice and environmental sustainability. Nia builds a portfolio of forward-thinking companies poised to play a key role in our transition to an inclusive, just, and sustainable economy.
Venk Reddy – Chief Investment Officer of Sustainable Credit Strategies, Osterweis Capital Management – a San Francisco-based asset manager established in 1983, offering both equity and fixed income investment strategies.
Matthew Blume, Director of ESG Research & Shareholder Activism, Pekin Hardy Strauss Wealth Management, managers of the Appleseed Fund – a Chicago-based independent advisory firm providing funds and separate account strategies for investors that support their values through impact and ESG investing.
Zin Bekkali, CEO, Silk Invest – a London-based advisory firm that invests in listed equities across Global Frontier Markets – predominantly in Africa, the Middle East, Frontier Asia and Latin America – with a strong focus on impact investing and has been a signatory to the UN Principles of Responsible Investing since 2011.
Our panelists responded to the following questions we posed to them.]
Hortz: Do you’re feeling that the warfare in Ukraine has reframed ESG/Impression supervisor and investor views on sure points? What are these areas and the way are they being rethought or refined?
Nia Impression Capital: Human rights have all the time been a important factor of ESG investing, although it took Russia’s assault on Ukraine to drive the subject onto our entrance pages. As with many ESG elements, the timing of many threat incidents is unpredictable and disregarded on the peril of each funding selections and infrequently the people concerned. This second is equal to the tide going out, leaving it clear to see the place each company and funding selections weighing revenue and human rights had been too casually thought-about.
Osterweis: Autocratic governments and navy aggression should not new to world historical past or to ESG buyers. The most important change to investor mindsets right here could also be of their definition of what international locations or conflicts pose ESG (and even monetary) dangers. We suspect each conventional and ESG buyers will rethink the possibilities {that a} authorities which beforehand appeared unproblematic or at the least tolerable may very well be considered as an aggressor or revealed to be a human rights violator just about in a single day. In some methods, this may increasingly favor corporations who’re keen to incur the prices of onshoring their beforehand outsourced enterprise models proactively, which is (at the least domestically) a stakeholder remedy challenge which can have all the time been value watching anyway.
On the whole, the willingness to take short-term ache for long-term achieve is extra more likely to be a advantage than it has been previously, which we hope will encourage corporations to take action and can encourage buyers to cease judging ESG primarily based on short-term efficiency metrics. We can not lose sight that ESG represents long-term threat, and it all the time has in our opinion. So, for ESG managers, I don’t imagine the warfare ought to have modified what we’re searching for, simply the place we’re trying; we should all the time proceed to solid a wider web as we intention to determine potential dangers to keep away from.
PekinHardy: I positively assume the warfare in Ukraine and the financial and political fallout that resulted has created tough new questions for some ESG/Impression managers to think about. For instance, ought to ESG evaluation prolong to the nation/nationwide degree? How would such evaluation be carried out, given that the majority ESG metrics used for firm evaluation wouldn’t be related on the nationwide degree? What framework can be used? Ought to corporations be held answerable for the actions of the governments of the nations during which they’re domiciled? If that’s the case, who decides which governmental actions are “acceptable” and which aren’t?
At any given time limit, dozens of countries are engaged in battle, so who decides which nations are worthy of funding and which aren’t? Given the complexity of those questions and their subjective nature, we imagine these concerns ought to be stored separate from ESG evaluation, however some ESG/Impression managers might grapple with such questions going ahead.
Silk: The continued warfare in Ukraine is turning into more and more a take a look at for buyers each on a rustic degree and sector degree. Previous broad consensus on, for instance, the filtering out of investments in weapon producers or much less excessive vitality corporations is being rethought.
Hortz: Ought to political ideologies and geopolitical conflicts grow to be an even bigger a part of ESG assessments? How then do you apply these points into portfolio development and inventory choice? Ought to political threat and worldwide battle be an even bigger a part of ESG assessments?
Nia Impression Capital: For all investing, geopolitical battle has all the time been a basic threat consideration. Political ideologies are solely a problem to the diploma they lead to disregard for human rights, social rights and extra just lately, the atmosphere. For any ESG technique, that is, or ought to be, an intrinsic factor of inventory choice and portfolio development. Whereas we might not obtain world settlement for requirements in apply, it’s incumbent upon buyers to think about how their investments may very well be exploiting a differential in these rights and whether or not that’s acceptable. Buyers who view these compromises in human rights as alternatives ought to acknowledge the inherent dangers and potential human rights violations during which they’re collaborating.
Osterweis: First, a caveat: We’re basic buyers who prioritize threat mitigation and materiality, so we view this query by means of that lens. Geopolitical conflicts have all the time been one thing a superb analyst ought to take note of. The place the conflicts are and what the results are might fluctuate, however a superb credit score analyst can not assume that an organization’s creditworthiness is just not associated to who they do enterprise with and the place.
We noticed this beforehand, with the Trump administration’s tariff warfare with China. Any firm that was not nimble sufficient to pivot encountered actual issues. Buyers who had been complacent concerning the rising animosity between the U.S. and China realized the exhausting method that what might have been a tolerable threat previously is just not an indicator of what ought to be a tolerable threat sooner or later.
The Russia/Ukraine battle uncovered only one extra instance of the place buyers held their noses as a result of they had been primarily centered on returns. It really works till it doesn’t. If the mandate of a portfolio is to time the markets, I suppose the technique would possibly work over the quick time period. But when the mandate is to be constant, and to raised align efficiency and progress over time, then such dangers ought to have all the time been on an analyst’s radar display.
PekinHardy: Geopolitical/nation threat evaluation has all the time been an necessary a part of the analysis course of for any worldwide funding. Nevertheless, we’ve all the time considered ESG evaluation and nation threat evaluation as separate elements of the analysis course of. ESG evaluation is a bottom-up, firm particular evaluation, whereas nation threat evaluation is top-down and focuses on the broader geopolitical and financial dangers of nations during which potential investments are positioned.
Our ESG evaluation applies particular, quantitative screening standards to corporations with respect to their enterprise involvement and appears at company-specific efficiency on numerous environmental, social, and governance standards. The nation of domicile is just not an element on this a part of the method.
For my part, introducing screens or assessments primarily based on purely ideological elements or taking sides in geopolitical conflicts can be extremely tough and fraught with threat. The world is a various place with an extremely various set of views, so attempting to include this into portfolio development would create untold challenges for managers. Any try to do that would want to begin with a transparent delineation of the particular ideological elements and positions which can be to be utilized within the portfolio development course of in order that buyers have a transparent understanding of the ideological positions that will probably be championed by the managers. There could also be a marketplace for such merchandise, however that isn’t our space of experience.
Silk: Assessing broad political dangers ought to be a important a part of ESG assessments however that doesn’t imply that it is best to routinely scale back or not put money into sure international locations. Investing in shares which can be primarily based in tough or hostile political environments ought to typically be seen as an instrument of partaking with company leaders and constructing alliances. The Russian scenario is kind of distinctive and shouldn’t essentially be seen as a base case for the long run.
A lacking level right here is whether or not buyers ought to allocate extra assets to strengthen alliances with “impartial” Rising and Frontier Markets. Western international locations would profit from a extra assertive “Marshall Plan” strategy and improve investments in Africa and Asia. In an more and more deglobalizing and/or multi-polar world, governments and buyers ought to use capital as a instrument to maintain their pure liberal habitat.
Hortz: The place are your ideas on whether or not protection shares, producing weapons free of charge societies’ safety, ought to be thought-about as ESG/impression eligible investments? Will not be pursuing nationwide protection an moral goal? And what concerning the constructive public sector improvements (GPS, nano cameras, and contact display) which have come from navy analysis?
Nia Impression Capital: Ideally, we direct funding {dollars} into diplomacy and people corporations enjoying a key position in our transition to a sustainable, equitable and honest economic system that works for everybody, as inequalities are sometimes a precursor to and a threat for geopolitical battle.
That stated, the sticky a part of this query lies in how the revenue motive provides an incentive to both wage warfare or to drive the “protection industrial complicated.” Ideally, assist for nationwide protection and the revenue motive wouldn’t entangle with damaging penalties, but the unlucky actuality is that they do.
Turning to the services, ESG buyers should weigh logistics and penalties rigorously. Communication or transportation providers are fairly totally different than weapons and fighter jets.
Authorities-backed and public-funded analysis in companies reminiscent of DARPA have undoubtedly resulted in lots of helpful improvements which have discovered purposes throughout transportation, healthcare, and know-how. We see no challenge with authorities funding of such analysis and are equally supportive of the sharing out of that analysis throughout non-defense industries.
Osterweis: This isn’t the primary time somebody has had the chance to justify an trade for ESG window-dressing functions. As a high-yield bond investor, how we view corporations with respect to ESG elements has all the time been necessary. I don’t assume it’s useful to label corporations nearly as good or dangerous. If one is really attempting to have impression, punishing an organization for the place they’re now’s hardly a progressive strategy. We imagine it makes extra sense to tug capital from corporations for not caring or attempting to make progress and provides it to those that are intentional about their targets to get higher. That is very totally different from justifying the nice an organization does in what could also be thought-about a vice trade.
The query to ask is just not, “Are they really good?”, however reasonably, “Do they see their blind spots and are they attempting to enhance?” If the reply to the latter query is sure, and so they efficiently execute, then the investor’s capital has contributed to that progress and has had impression within the course of, even within the non-voting world of mounted revenue. But it surely all comes again to the intentionality of an organization to raised itself, and never simply in core merchandise, however in all the ESG elements which can be materials to the enterprise.
In the meantime, from a sensible perspective and particularly because it pertains to protection and weapons, no quantity of justification adjustments the headline and occasion threat related to these corporations which fairly frankly makes them tough investments for an ESG investor like us to think about.
PekinHardy: That is one other actually tough query as a result of it relies upon a lot on an individual’s particular person perspective. Whereas arguments will be made for build up navy functionality as a way to pursue “humanitarian” goals or for “protection,” this type of factor all the time comes down to at least one’s private scenario. Whereas some would possibly take into account one nation’s navy engagements to be virtuous, somebody on the opposite finish of such motion would possibly assume in any other case. And what one individual would possibly take into account “protection,” one other might discover fairly offensive. Because of this, we discover it greatest to easily keep away from funding in protection/weapons corporations inside our mutual fund in order to avoid this challenge solely.
The know-how growth argument is usually made to justify protection spending, and there’s no doubt that extremely necessary applied sciences have emerged from efforts to reinforce navy capabilities. Nevertheless, I feel it may possibly simply be argued that with the identical assets at their disposal, governments, corporations, and academic establishments may have developed the identical applied sciences within the pursuit of peaceable goals. Given the prevalence of value overruns and the shortage of effectivity within the protection trade, one would possibly even argue that technological development within the pursuit of peaceable goals may happen at a fraction of the historic monetary value and with out the human value.
Silk: A tough query that would simply be a slippery slope. As a agency, we, subsequently, imagine that each one protection shares ought to nonetheless be off-limit inside an ESG/impression portfolio. Navy analysis has contributed to public sector improvements, however these improvements or higher ones may have been created if the identical assets would have been allotted to different sectors.
Hortz: What different ripple results of the Russia-Ukraine warfare do you’re feeling could have profound penalties for ESG and impression fund managers and markets? Will this warfare set off a sooner transition in the direction of clear vitality?
Nia Impression Capital: As we’re already seeing, Europe has related the dots about their oil sources – in addition to the fossil gasoline pipelines operating throughout borders. European funds are flowing towards renewable options, which in the long term will diminish reliance and dependence on Russia and on its oil.
Sadly, the funding atmosphere has tightened up, together with the slowing of the economic system. That would seem to bode poorly for near-term acceleration of investments into clear vitality.
One of many largest impacts will probably be an acceleration of the trouble to tug sourcing towards extra dependable and safe companions and sources. A constructive from this case is that corporations and buyers will proceed to achieve higher visibility into provide chains. Better transparency can be one super constructive for all of ESG, impression fund managers, and markets.
Osterweis: With respect to scrub vitality, particularly, this warfare has created a short-term provide shock. If somebody invests in clear vitality due to a short-term short-term impact, we imagine they’re setting themselves up for disappointment if the atmosphere normalizes. That stated, ESG has already had an impression on the vitality area, however maybe not solely in the way in which we’re discussing right here. Positive, extra funding has gone into clear vitality, however there has additionally been a capital constraint on conventional vitality investing. That is precisely the target of many ESG buyers who see themselves as voting with their cash.
Nevertheless, since oil and pure gasoline are commodities, the capital constraint inevitably results in provide constraints that are extra persistent and far more impactful than the short-term provide shocks from conflicts reminiscent of this one. These provide constraints, in flip, drive the commodity costs up, once more not quickly however with a extra fixed upward stress. This in flip makes inflationary pressures really feel extra persistent. However these greater commodity costs can also drive a greater return for individuals who do select to put money into that area or are already there, making them doubtlessly extra worthwhile and exacerbating the efficiency vs. progress notion.
In the end, such short-term catalysts are usually counterproductive to long-term change, and whereas we count on there will probably be extra consciousness associated to how concentrated the fossil gasoline geopolitical energy dynamic truly is, buyers shouldn’t lose concentrate on the truth that making clear vitality economically equal always is extra long-lasting.
PekinHardy: There is no such thing as a query that the disruption of world vitality markets has precipitated buyers and policymakers to rethink vitality methods. Vitality markets had been already beneath stress previous to the Russia-Ukraine battle, however the shutting off of Russian vitality from world markets and the numerous financial penalties of this disruption confirmed us simply how fragile our present vitality methods actually are. This positively argues for some new considering with regard to vitality. This new considering ought to most definitely concentrate on increasing the usage of renewable vitality sources and accelerating technological growth throughout the renewables area as a way to diversify away from extra conventional vitality sources. I additionally assume it ought to put nuclear vitality again into the highlight as an necessary piece of the clear vitality puzzle.
Taking a look at markets extra broadly, I feel the largest impression of this battle will probably be an acceleration of deglobalization. This development was underway previous to the outbreak of warfare in Ukraine, however the Russian invasion and the massive impacts it had on markets and provide chains has pushed this course of into overdrive. The world is bifurcating and turning into multi-polar, which is able to result in a re-shoring of sure industries, a reshuffling of provide chains, and sadly, possible poorer worldwide relations all over the world.
Silk: Long run, the world may see a sooner transition to scrub vitality, however buyers shouldn’t underestimate that the present warfare might impression the potential out there assets to finance transition. The inducement of transition has elevated, however the world might have much less capital to deploy, and the present inflationary pressures might structurally improve the price of capital.
Hortz: How can an funding supervisor calibrate wide-ranging, generally conflicting company actions into an ESG/Impression rating or profile? How do you think about when an organization does “the proper factor” like exiting enterprise in Russia versus the monetary hit that the corporate took in exercising their social conscience?
Nia Impression Capital: ESG due diligence is complicated and entails monitoring many distinct points of an organization enterprise mannequin. Each firm has positives and negatives that should be weighed and in contrast in the midst of figuring out its funding advantage. As with conventional monetary metrics, some ESG elements could also be disqualifying, just like a particularly excessive leverage ratio or collapsing margins. Additionally, simply as in conventional monetary evaluation, not all portfolio managers will attain the identical conclusions when trying on the similar knowledge. So, it ought to be no shock that when analogous comparisons are made with ESG elements, there will probably be a spread of opinions, particularly when firm elements should not on the extremes. Whereas one investor might take into account sure actions and elements disqualifying, others might view them as mitigated by offsetting positives elsewhere.
Osterweis: I feel scoring is a widespread mistake in ESG investing. The notion that there are good corporations and dangerous corporations doesn’t map to actuality. It’s extremely oversimplifying, and, at the least in mounted revenue, this isn’t an efficient method to make use of capital to have a constructive impression. Because of this, we are likely to focus much less on methods to “rating” conflicting behaviors throughout numerous ESG elements and extra on whether or not an organization is intentional about making progress in every of the ESG elements that are materials to their enterprise. On this method, we are able to take away the dissonance created by the necessity to boil each issuer all the way down to a quantity and as a substitute make selections primarily based on that issuer’s upkeep or progress in quite a lot of areas.
Particularly, relating to the monetary hit of exiting Russia for instance, this can be a actual challenge for ESG portfolios proper now as a result of the market nonetheless cares most about short-term outperformance. However it’s considerably unfair to say that an organization is exiting enterprise in Russia to train their social conscience. There are all the time penalties to each motion, and the uncertainty of the results of not exiting these companies possible performs as large a job within the determination. We don’t but understand how this can play out over time, and it hardly ever advantages buyers to attempt to attract big-picture conclusions in the course of an evolving scenario. Given the danger of political, legislative, and grassroots repercussions, we’re not satisfied that corporations who’re standing by their Russia-related revenues will come out forward in the long term.
PekinHardy: This actually will get to the guts of the problem of managing an ESG portfolio. There are merely some concerns that can not be quantified, so incorporating them into some type of rating or grade is successfully unimaginable. This is a matter that ESG managers have been coping with for a very long time. It’s merely unavoidable that sure elements are subjective, and two totally different managers can have a look at the identical set of points and are available down on reverse sides. Or they could prioritize goals otherwise.
Take, for instance, a big vitality firm whose major enterprise is the manufacturing of fossil fuels however which additionally engages closely in analysis and growth round renewable vitality. One ESG supervisor might even see this firm as an necessary a part of the long-term resolution to local weather change, whereas one other ESG supervisor might even see this firm as uninvestable. Who is correct? It will depend on your perspective. This type of challenge can materialize in a myriad of various contexts, creating enormous challenges for ESG managers. For this reason it’s so necessary for ESG managers to be very specific about their strategy to ESG and which ESG goals they’ll pursue and prioritize of their portfolio.
Silk: Sacrificing monetary returns for moral or social goals ought to be supported, however the tougher query is assessing the damaging social impression of sure actions. Exiting companies in Russia might assist the Ukrainians, however can also drastically impression the lives of harmless Russians. Thankfully, many corporations are taking this into consideration and have, for instance, supplied Russian-based workers an affordable “termination” compensation.
Hortz: On account of the challenges and points introduced up by the warfare in Ukraine, do you’re feeling they’ll act to strengthen the ESG/Impression funding area going ahead?
Nia Impression Capital: The Ukraine warfare has introduced into the daylight variations of interpretation and implementation of ESG/Impression investing. To the extent that highlighting these points results in a consensus that buyers and practitioners should clearly articulate their strategy to human and social rights in funding practices, it may possibly solely be a constructive consequence.
Osterweis: I feel the ESG/impression supervisor goes to have a near-term downside due to the warfare. We now have seen a number of corporations report decrease earnings as a result of lack of income from pulling out of enterprise in Russia. This may most definitely gasoline the hearth of ESG skeptics, who argue that efficiency and progress should not correlated. Sadly, the counterargument that an organization may get damage much more badly by grassroots boycotts or different enterprise losses, whereas doubtlessly legitimate, is unprovable. Nevertheless, the silver lining right here is that perhaps the market will lastly admit that ESG elements are threat elements, not efficiency elements, and that when considered correctly, the 2 are certainly aligned.
Being threat managers is just not within the language of many buyers these days, with fundamentals taking a backseat to beta and indexing, however ESG dangers are largely long-term dangers. So long as most buyers choose a portfolio by short-term efficiency relative to a standard benchmark, these headwinds will persist, and this warfare has not helped change that notion. Nevertheless, throughout the subset of the markets during which ESG investing is already a precedence, we’re optimistic that this battle will shift buyers away from the standard knowledge, which have damage the notion of ESG (e.g. damaging screening, short-term efficiency) in favor of a longer-term strategy during which efficiency and progress will be extra in sync (e.g., built-in funding processes, long-term risk-adjusted returns).
PekinHardy: It has already had the impact of getting folks to assume far more critically about what ESG actually entails and the way it ought to be carried out in right this moment’s world. Questions like these above are being requested extensively for the primary time. The place folks in the end come down on these questions stays to be seen, however I feel it has the potential to basically alter the way in which we apply ESG evaluation going ahead. It’s my hope that ESG methods will discover extra assist and that extra managers will probably be compelled to use these elements of their funding evaluation on account of this episode, however we must wait and see on that.
Silk: The present warfare is an effective take a look at for the neighborhood and can assist buyers to develop new greatest practices in ESG/Impression investments.
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