ESG: except when it’s going up

European fund managers have long been at the forefront of ESG investing. They have driven environmental change, demanded improvements to corporate governance, and sought a more rounded understanding of a business’s impact on society. From a sales point of view, however, this can mean that certain sectors—gambling, fossil fuels, defence stocks—are difficult to broker at times. Ideas in these areas would often fall on deaf ears, either due to hard mandates or the understandable preference among some end-investors to avoid companies deemed unpalatable for other, softer reasons.

And then Russia invaded Ukraine.

Suddenly, as energy pipelines out of Russia were shut off and oil and gas prices shot up, so did—miraculously—the ethical justifications for investing in them. Portfolio managers who once shunned hydrocarbon assets, taking great pride in their green credentials, quietly made room for positions in fossil fuels—all in the name of energy security, of course. Whether their environmental stance softened because of rocketing share prices, or share prices rocketed because of a softening environmental stance, is debatable, but I strongly suspect it is more likely the former.

It is not that fund managers are hypocrites. It is just that ESG investing, it turns out, is somewhat more flexible than advertised. Indeed, it appears that many Article 8 and 9 funds—which are regulated by the EU’s Sustainable Finance Disclosure Regulation rules—have no qualms about investing in oil giants, justifying it on the grounds that their influence can encourage a transition to cleaner energy. Ethics? Yes—but not at the expense of returns. The ice caps may be melting, but so is alpha if you are not in the right sectors.

Once again, following the European Commission’s announcement in March of an €800bn rearmament plan, we are seeing moral gymnastics at play. With money set to pour into the European defence sector, we recently roadshowed Melrose—a global aerospace business that serves both civil and defence markets—in Stockholm. That combination would not have been possible a few years ago. But now, in the shadow of war in Europe and an increasingly precarious geopolitical order, all five funds we met said they are dropping their blacklist of defence-exposed stocks and welcoming them back, arms wide open.

“It’s not about supporting conflict, we’re supporting defence,” as one PM put it. Some may see this as a neat linguistic sidestep, but there is a grain of truth to it. The Doomsday Clock has ticked forward to 89 seconds before midnight, a worrying sign that humanity has edged closer than ever to catastrophe. The world has changed, and so, perhaps, must our definition of ‘ethical’.

Morals and values are not fixed; they necessarily fluctuate and evolve with the times. Sometimes they even come full circle. What is important under one set of circumstances becomes augmented under a different reality. Investors are trying—sometimes clumsily, often inconsistently—to reflect that changing world in their portfolios. It might mean electric vehicle components are substituted for tank parts, or wind farms get replaced with liquefied natural gas terminals.

Perhaps that is not hypocrisy so much as adaptation. The late British economist John Maynard Keynes said it best: “when the facts change, I change my mind—what do you do, sir?

 

Charlotte Carter,

UK Equity Sales – Continental Europe

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