Earlier this year Swedish bank SEB announced it was reversing a blanket ban on the defence sector.
This change to its sustainability policy, sparked by Russia’s invasion of Ukraine, may only have applied to a handful of its funds, but was nonetheless significant.
The decision (and others like it) reopened a debate on the rights and wrongs of putting your money into weapons manufacturers and other associated businesses.
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 environmental, social and governance factors, aka ESG. Has war really changed the rules on sustainable investing?
Do weapons have a place in ESG?
Shares in several companies with defence interests saw huge rises following the start of the war in Ukraine. Saab, which makes fighter planes, saw its price more than double from the end of the February to early May.
Up until the end of last year, the trend appeared to be going the other way. Increasingly there was pressure on big investors (such as Norway’s sovereign wealth fund) to view defence as an ESG risk.
The likes of Rolls Royce, Thales and Airbus argue that what they do helps maintain greater global security and stability. Since war broke out, the question is being asked, without those two components, is sustainability even possible? Earlier this year, a note from Citi analysts argued: “we believe defence is likely to be increasingly seen as a necessity that facilitates ESG as an enterprise, as well as maintaining peace, stability and other social goods.”
What does this mean for ESG funds? There are a few 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.