The unfolding tragedy of the war in Ukraine has provoked a wide range of news coverage and rightly so. Amongst the war stories and market impact of Russian aggression, a rather unexpected consideration has emerged, namely, whether weapons represent an ESG investment.
It may appear absurd, at first glance, to consider proposing a thesis whereby instruments of death and destruction could be classified in the same breath of renewable energy and educational companies but, according to reporting in the New York Times, bankers at Citi believe that “defending the values of liberal democracies and creating a deterrent, which preserves peace and global stability” is indeed a ESG investment.
One thing is very clear from the data – war is profitable. Weapons company stocks soared on news of a significant war erupting Lockheed Martin (NYSE: LMT) is up around 20% YTD at the time of penning this blog.
Irrespective of financial motivations for investing in weapons of mass destruction (WMDs) or including them into ESG indices, there seems to have been lack of acceptance to embrace the Citi bankers’ suggestion to make WMDs green.
Further reported by the Times, Leslie Samuelrich, president of the Green Century Funds, was clear on her view as a dedicated ESG investor: “Those who argue that weapons belong in a sustainable portfolio are capitalizing on the horrific attack,” she said. “Excluding military and civilian firearms has been a long-held screen by authentic responsible investors.”
With the subject trending, Citywire went further analysing existing ESG funds as to whether those funds were exposed to weapons companies. The results of their research were shocking. Citywire journalist Siri Christiansen suggested that a third of Europe’s Article 8 (green) and 9 (dark green) funds have controversial weapons exposure.
Given the express and implied goals of the EU Sustainable Finance Directive, namely to target investment in environmental themes and avoid significant harm, the findings were indeed surprising. However, like many considerations of ESG investing, the findings were somewhat nuanced by the fact that some data reporting agencies classified some companies as ESG friendly whereas other investors did not.
Companies such as Airbus SE (AIR.PA), Thales (HO.PA) and even champions of energy transition Brookfield (NYSE: BAM) have been earmarked as companies with connections to military and weapons revenues yet were seeming greenlit for ESG investing by certain ESG data providers. However, investors conducting their own due diligence found that these companies should be captured by a negative screen on weapons companies.
The debate around ESG themes and where the grey areas exist is one that seems likely to continue. Outside the realm of WMDs and military contracts, debate even exists on whether tobacco companies are ESG investments.
Whilst some such as Tobacco Free Portfolios, the Australia-based pressure group, would never consider tobacco as ESG, ratings agencies such as Dow Jones disagree making Philip Morris (PMI) a “sustainability leader”. Per the press release announcing this triumph for PMI:
“Underpinning PMI’s inclusion in the index, the company scored 84 (out of 100) in the 2021 S&P Global Corporate Sustainability Assessment, reflecting an improvement of 10 points over the prior year and a top decile position in the tobacco industry.1 Importantly, PMI led the tobacco industry in 10 of the 24 criteria assessed1, including Innovation Management, which evaluates companies’ research and development spending, product innovations, and portfolio of tobacco alternatives and smoke-free products”.
There’s no reason to doubt the factual accuracy of the above quote, however where ESG investing differs from impact is also the consideration of negative impacts. For example, both weapons and tobacco companies can be seen to detract from multiple UN sustainable development goals (SGDs). For example, tobacco negatively contributes to SDG1 (No Poverty) as poor people spend money on cigarettes and both tobacco and weapons negatively contribute to health as both, well, kill people. We could go on…
Investors seeking genuine positive contributions are increasingly focussed on impact investing rather than ESG on its own. ESG often provides a solid risk screen to avoid the worst harm but even weapons and tobacco companies could be found in an ESG portfolio.
Whilst impact managers screen for negative ESG risks, they also must account for negative impact from company activities. For example, the negative impact caused by cigarette filters that take up to 1000 years to decompose or how education or healthcare is set back when a bomb destroys a school in Yemen or a hospital in the Ukraine.
ESG provides an important screening process however for investors that are seeking value alignment with overwhelmingly positive impact on the world and across SDGs impact investing is the way forward. Increasingly investors are seeking out this alignment to steer portfolios towards an overwhelmingly positive impact on the environment and society with the need for smokes or bombs.
Alex Wise is the Chief Operating Officer at WON Impact Asset Management
