An investing movement that promotes itself as a protector of people and the planet has somehow found itself providing capital to the autocratic regime behind Europe’s worst military conflict since World War II.
Funds labeled ESG – an acronym that denotes a commitment to environmental, social and governance interests – own shares of Russia’s state-backed energy behemoths Gazprom PJSC and Rosneft PJSC, as well as its biggest lender Sberbank PJSC. The funds also hold Russian government bonds, providing money that ultimately helped pad the coffers of President Vladimir Putin’s autocracy.
Paul Clements-Hunt, who led a group that coined the term ESG back in the mid-2000s, said it’s now clear that “ESG investors have failed.”
“ESG is being used ineffectively,” said Clements-Hunt, founder of advisory firm Blended Capital Group. Investors should be measuring risks across entire systems not just corporate risks, but instead, “the obsession with easy money-making is overriding everything,” he said.
Russia’s invasion of Ukraine is rapidly laying bare unexpected exposure in much of the ESG universe. Industry researchers at Morningstar Inc. estimate that 14 per cent of sustainable funds globally held Russian assets right before the war. That’s as sustainable investing morphs into a $40 trillion industry embraced by the financial behemoths of Wall Street, where funds that track benchmark indexes are ubiquitous.
“Ukraine is one of the most important ESG issues we’ve ever had,” said Philippe Zaouati, chief executive of Mirova, the $30 billion sustainable-investing unit affiliated with Natixis Investment Managers. “It’s a vital issue for energy and human rights, and questions whether we still want to live in a democracy or not.”
But those representing the more mainstream side of ESG investing argue the term is widely misunderstood. It is, in fact, just a screening tool to protect investments from environmental, social and governance risks, according to some of the biggest firms working with and analyzing ESG data.
“There are still people who inappropriately conflate sustainability and ethics,” said Hortense Bioy, Morningstar’s global head of sustainability research. “Sustainable and ESG funds aren’t the same as ethical funds.”
For that reason, ESG funds can buy everything from makers of conventional weapons to producers of fossil fuels. The world’s biggest ESG-focused exchange-traded fund — BlackRock Inc.’s $23.7 billion iShares ESG Aware MSCI USA — holds shares of companies ranging from Raytheon Technologies Corp. to Exxon Mobil Corp.
Bioy said ESG portfolio managers, “just like any other managers holding Russian assets or not, will be evaluating the situation and trying to understand the broader implications of the conflict and impact on their portfolios.” The war “has broader implications for ESG investors than just ethical ones,” she said.
Others point out that rejecting Russian assets entirely also can mean cutting off good companies. These often include technology firms that are actively trying to provide transparency in defiance of Putin’s restrictions.
Rachel Robasciotti, founder of Adasina Social Capital in San Francisco, which runs an $89 million ETF that focuses on social justice issues, said that unless a business is clearly an instrument of a despotic regime, it’s important to differentiate between companies and the countries in which they operate.
“We don’t punish companies for the actions of the country where they are headquartered,” she said.
Boston Common Asset Management, one of the oldest socially responsible investors, owned shares of Russian search engine Yandex NV because it seemed to be “contributing positively to democracy in Russia,” said Kevin Hart, the firm’s head of marketing. The tech company had even adopted a code of conduct that addressed human rights and supply chain issues, he said. But the $6 billion investment firm ended up selling its stake in Yandex last month, partly because of the risk of a U.S. ban on owning Russian assets, he said.
Mirova’s Zaouati said this should be a moment of recalibration for ESG investors. “We have to decide what we do with the Russian government and all companies linked to the Russian government,” he said. “We have to decide what we will do with other autocratic regimes.”
Asking that question has led Mirova to exclude not just Russian, but also Chinese assets.
Felix Boudreault, managing partner at research firm Sustainable Market Strategies in Montreal, said he’s been warning clients to stay out of Russia since 2018, and is now giving the same advice about China.
“As an investor, you have to consider not just the company, but the environment in which they operate,” Boudreault said. “And we are saying the same for China. It’s uninvestable from any ESG perspective. By a strike of a pen, a bureaucrat in Beijing can really kind of wipe out an entire sector like they did with education technologies recently.”
Clements-Hunt, who was among a group of ESG pioneers that included the now-deceased United Nations Secretary General Kofi Annan, said the answer is clear.
“If you don’t factor in autocracy and a malevolent government, then you have failed in your ESG assessment,” he said.
© 2022 Bloomberg L.P.