In the past few weeks, much has been written about the impact of Russia’s invasion of Ukraine on ESG investing. Critics have accused portfolio managers – including those of ESG funds – of failing to foresee the risks that Russia’s autocratic regime could pose to their portfolios. ESG ratings agencies have also been criticised for failing to reflect the full risks of a Russian invasion of Ukraine in their ratings.
Others have suggested true ESG investors should divest not only from Russia but also China, another autocratic state with close ties with Russia and which also has a poor human rights record.
Underlying these criticisms is the assumption that ESG is this new perfect lens through which investors can view the world and which provides them with the ethical compass they need to guide their investment decisions.
The reality is there is a variety of ways and motivations for doing ESG. To align with their values, some investors just want to avoid bad corporate actors and totalitarian states, while other investors prefer to focus on ESG issues that are financially material, and a significant and growing group want their investments to have real-world impact.
Different motivations often lead to different investment decisions. However, at times they can lead to the same decisions and portfolio outcomes. In the case of the Ukraine conflict, many asset managers have decided to divest from Russia, but not for the same reasons: some have divested on ethical grounds, others because of heightened ESG and geopolitical risks, while others have divested because of the economic sanctions imposed by Western governments on Russia. Some managers have simply suspended new Russian investments because they have no other choice: the Moscow stock exchange was closed, making trading practically impossible.
For the benefit of investors, asset managers should be open about what has guided their decisions to divest or pause. Some have been transparent and clear, others less so. More than ever, investors want to better understand the role ESG plays in their managers’ investment decisions and what outcomes to expect. The conflict in Ukraine is an opportunity for asset managers to engage in deeper dialogues with their clients on the different ESG approaches, the implications of each approach, and provide greater clarity on their own ESG philosophy.
Equally, the conflict is an opportunity for investors to determine whether the ESG approaches employed by their investments are consistent with their own expectations on sustainability and ethics. Some investors may find the funds they own don’t go far enough in their incorporation of ESG or incorporate enough moral consideration and they may want to switch to alternatives that better reflect their individual sustainability preferences and values.
Being open about what motivated decisions to keep or sell Russian assets may also help investors better predict what managers will do when Russia re-opens for business. Managers of strategies that use ESG only as a risk mitigation tool may well go back into Russian banks and oil and gas companies if they think the potential returns justify the risks. Sustainability-focused managers, on the other hand, are unlikely to go near these assets for the foreseeable future.
That said, knowing a manager’s current stance on Russia doesn’t address the elephant in the room: what to do about China? China’s position as the world’s second largest economy, along with its 30% weighting in the emerging market benchmark, makes it almost impossible to avoid. Investors considering divesting their Chinese assets should be aware they will likely remain exposed to the country, indirectly, as most companies are linked to China through the global supply chain. In addition, as the world’s largest market for renewable energy, China happens to offer significant opportunities that ESG investors may not want to forego.
The Ukraine conflict has reminded us that ESG has evolved from being an ethical screen to a more comprehensive lens through which investors can make wide-ranging investment decisions. This new lens is, and will certainly need to be, constantly fine-tuned to capture a more complex reality full of unexpected events that challenge our values and the way we see the world.