Investors seem stuck in their ways – one might say entrenched – having not appeared to reassess their approach to political risk or defence stocks following the war in Ukraine.
As part of our annual Sustainable Investment Survey, we asked asset managers a series of questions arising from Russia’s unprovoked invasion of Ukraine. We wanted to understand what lessons they’d learnt, what fresh thinking this had inspired and what may change as a result.
Depressingly, the answer seems to be ‘not much’
The greatest number of responses to the war – from almost half of the surveyed asset managers– amount to little more than platitudes and acknowledgements that they will comply with sanctions. A further quarter of asset managers pointed us to detailed investment advice discussing the immediate and broader implications of the invasion.
An area we particularly pressed managers on was how the war may have influenced their views or approach to the defence sector.
Asset managers’ bark appears greater than their bite
Although around a quarter of respondents say that they’re reconsidering their approach to the defence industry as a result of the war, only seven provide any substantial commentary on what this might look like. Most of these simply confirm that they retain their prior approach, with only three showing substantive evidence of thoughtful reconsideration.
An area highlighted by one manager was the spotlight the war had placed on weapons investing and the eligibility of defence spending to be classified as a sustainable economic activity. They raised the point that, if conventional weapons used for defence are moved off restricted lists, it’s not a given that they would be included in ESG funds. Rather, they felt managers would need to work closely with clients to determine the potential scope of limitation for ESG investment in this area and whether they felt an allocation of any nature would be appropriate.
This is somewhat surprising to us as our dialogue with large institutional clients suggests that the majority of mainstream institutions are already supportive of investments in defence stocks – once manufacturers of the small number of truly controversial, indiscriminate weapons (cluster bombs, anti-personnel mines, biological, chemical and so on) are excluded. It’s only a read-across from certain retail fund approaches to ESG matters that leads some asset managers to exclude the entire defence industry. Such investments can make sense financially: these are typically robust, cash-generative businesses with visible long-term order books that are, in most cases, underwritten by implicit government guarantees. And the assault on Ukraine reminds us that ‘defence’ is a highly appropriate name for the sector.
There’s some confusion around what existing exclusion policies cover
It appears that asset managers may not themselves understand their approaches in detail, or are confused by what it is they want to be seen to be doing. A third of respondents state that they have a general restriction on defence industry investments as part of their standard ESG approach, beyond excluding manufacturers of controversial weapon systems. However, a brief analysis of the data shows that only a third of these state that their policies do in fact go beyond excluding that narrow group of indiscriminate weapons. If they themselves don’t fully understand their policies, it’s not surprising that defence stocks remain under-invested and excluded from ESG portfolios – despite our understanding that many institutional clients would be happy to have some exposure.
Contradictions abound in this area. One response to our survey stated that the asset manager made no defence exclusions on principle – citing the view that weapons can play a role in both war and peace – but that in practice the sector as a whole was excluded. The reasoning being that no company could guarantee that such weapons, via being exported or re-exported, would not be used capriciously or against civilians.
We think that clients deserve more clarity of thought and refreshed approaches in this area. That might include investors developing more robust antennae for political risk and the steady deterioration in investment cases that come from human rights abuses and breaches of the rule of law. It might require more stress-test scenario analysis of the potential impacts of other geopolitical upheavals – we seem to have entered a less stable period for the world, and investors need to be ready for it. It will undoubtedly demand greater clarity on investor exclusion policies, and that these accurately reflect client expectations and interests.
The war should be shaking our complacency more than it appears to have. Read the full survey to discover more insights like these.
Unless indicated, these are the views of the author and may differ from those of the firm.