At any given point in time, dozens of nations are engaged in conflict, so who decides which nations are worthy of investment and which are not? Given the complexity of these questions and their subjective nature, we believe these considerations should be kept separate from ESG analysis, but some ESG/impact managers may grapple with such questions going forward.
Silk: The ongoing war in Ukraine is becoming increasingly a test for investors both on a country level and sector level. Past broad consensus on, for example, the filtering out of investments in weapon producers or less extreme energy companies is being rethought.
Hortz: Should political ideologies and geopolitical conflicts become a bigger part of ESG assessments? How then do you apply these issues into portfolio construction and stock selection? Should political risk and international conflict be a bigger part of ESG assessments?
Nia Impact Capital: For all investing, geopolitical conflict has always been a fundamental risk consideration. Political ideologies are only at issue to the degree they result in disregard for human rights, social rights and more recently, the environment. For any ESG strategy this is, or should be, an intrinsic element of stock selection and portfolio construction. While we may not achieve global agreement for standards in practice, it is incumbent upon investors to consider how their investments could be exploiting a differential in these rights and whether that is appropriate. Investors who view these compromises in human rights as opportunities should acknowledge the inherent risks and possible human rights violations in which they are participating.
Osterweis: First, a caveat: We are fundamental investors who prioritize risk mitigation and materiality, so we view this question through that lens. Geopolitical conflicts have always been something a good analyst should take into account. Where the conflicts are and what the consequences are may vary, but a good credit analyst cannot assume that a company’s creditworthiness is not related to who they do business with and where.
We saw this previously, with the Trump administration’s tariff war with China. Any company that was not nimble enough to pivot encountered real problems. Investors who were complacent about the growing animosity between the U.S. and China learned the hard way that what may have been a tolerable risk in the past is not an indicator of what should be a tolerable risk in the future.
The Russia/Ukraine conflict exposed just one more example of where investors held their noses because they were primarily focused on returns. It works until it doesn’t. If the mandate of a portfolio is to time the markets, I suppose the strategy might work over the short term. But if the mandate is to be consistent, and to better align performance and progress over time, then such risks should have always been on an analyst’s radar screen.
PekinHardy: Geopolitical/country risk analysis has always been an important part of the research process for any international investment. However, we have always viewed ESG analysis and country risk analysis as separate parts of the research process. ESG analysis is a bottom-up, company specific analysis, whereas country risk analysis is top-down and focuses on the broader geopolitical and economic risks of countries in which potential investments are located.
Our ESG analysis applies specific, quantitative screening criteria to companies with respect to their business involvement and looks at company-specific performance on various environmental, social, and governance criteria. The nation of domicile is not a factor in this part of the process.
In my opinion, introducing screens or assessments based on purely ideological factors or taking sides in geopolitical conflicts would be incredibly difficult and fraught with risk. The world is a diverse place with an incredibly diverse set of perspectives, so trying to incorporate this into portfolio construction would create untold challenges for managers. Any attempt to do this would need to start with a clear delineation of the specific ideological factors and positions that are to be applied in the portfolio construction process so that investors have a clear understanding of the ideological positions that will be championed by the managers. There may be a market for such products, but that is not our area of expertise.
Silk: Assessing broad political risks should be a critical part of ESG assessments but that does not mean that you should automatically reduce or not invest in certain countries. Investing in stocks that are based in difficult or hostile political environments should in most cases being seen as an instrument of engaging with corporate leaders and building alliances. The Russian situation is quite unique and should not necessarily being seen as a base case for the future.
A missing point here is whether investors should allocate more resources to strengthen alliances with “neutral” Emerging and Frontier Markets. Western countries would benefit from a more assertive “Marshall Plan” approach and increase investments in Africa and Asia. In an increasingly deglobalizing and/or multi-polar world, governments and investors should use capital as a tool to sustain their natural liberal habitat.
Hortz: Where are your thoughts on whether defense stocks, producing weapons for free societies protection, should be considered as ESG/impact eligible investments? Is not pursuing national defense an ethical objective? And what about the positive public sector innovations (GPS, nano cameras, and touch screen) that have come from military research?
Nia Impact Capital: Ideally, we direct investment dollars into diplomacy and those companies playing a key role in our transition to a sustainable, equitable and fair economy that works for everyone, as inequalities are often a precursor to and a risk for geopolitical conflict.
That said, the sticky part of this question lies in how the profit motive adds an incentive to either wage war or to drive the “defense industrial complex.” Ideally, support for national defense and the profit motive would not entangle with negative consequences, yet the unfortunate reality is that they do.
Turning to the products and services, ESG investors must weigh logistics and consequences carefully. Communication or transportation services are quite different than weapons and fighter jets.