Government backed and public funded research in agencies such as DARPA have undoubtedly resulted in many valuable innovations that have found applications across transportation, healthcare, and technology. We see no issue with government funding of such research and are equally supportive of the sharing out of that research across non-defense industries.
Osterweis: This is not the first time someone has had the opportunity to justify an industry for ESG window-dressing purposes. As a high yield bond investor, how we view companies with respect to ESG factors has always been important. I do not think it is helpful to label companies as good or bad. If one is truly trying to have impact, punishing a company for where they are now is hardly a progressive approach. We believe it makes more sense to pull capital from companies for not caring or trying to make progress and give it to those who are intentional about their goals to get better. This is very different from justifying the good a company does in what may be considered a vice industry.
The question to ask is not “Are they actually good?” but rather “Do they see their blind spots and are they trying to improve?” If the answer to the latter question is yes, and they successfully execute, then the investor’s capital has contributed to that progress and has had impact in the process, even in the non-voting world of fixed income. But it all comes back to the intentionality of a company to better itself, and not just in core products, but in all of the ESG factors that are material to the business.
Meanwhile, from a practical perspective and specifically as it pertains to defense and weapons, no amount of justification changes the headline and event risk associated with these companies which quite frankly makes them difficult investments for an ESG investor like us to consider.
PekinHardy: This is another really difficult question because it depends so much on a person’s individual perspective. While arguments can be made for building up military capability in order to pursue “humanitarian” objectives or for “defense,” this sort of thing always comes down to one’s personal situation. While some might consider one nation’s military engagements to be virtuous, someone on the other end of such action might think otherwise. And what one person might consider “defense,” another may find quite offensive. For this reason, we find it best to simply avoid investment in defense/weapons companies within our mutual fund so as to steer clear of this issue entirely.
The technology development argument is often made to justify defense spending, and there is no doubt that incredibly important technologies have emerged from efforts to enhance military capabilities. However, I think it can easily be argued that with the same resources at their disposal, governments, companies, and educational institutions could have developed the same technologies in the pursuit of peaceful objectives. Given the prevalence of cost overruns and the lack of efficiency in the defense industry, one might even argue that technological advancement in the pursuit of peaceful objectives could occur at a fraction of the historical financial cost and without the human cost.
Silk: A difficult question that could easily be a slippery slope. As a firm, we therefore believe that all defense stocks should still be off limit within an ESG/impact portfolio. Military research has contributed to public sector innovations, but those innovations or better ones could have been created if the same resources would have been allocated to other sectors.
Hortz: What other ripple effects of the Russia-Ukraine war do you feel will have profound consequences for ESG and impact fund managers and markets? Will this war trigger a faster transition towards clean energy?
Nia Impact Capital: As we are already seeing, Europe has connected the dots about their oil sources–as well as the fossil fuel pipelines running across borders. European funds are flowing toward renewable solutions, which in the longer term will diminish reliance and dependence on Russia and on its oil.
Unfortunately, the funding environment has tightened up, along with the slowing of the economy. That would appear to bode poorly for near-term acceleration of investments into clean energy.
One of the largest impacts will be an acceleration of the effort to pull sourcing toward more reliable and secure partners and sources. A positive from this situation is that companies and investors will continue to gain greater visibility into supply chains. Greater transparency would be one tremendous positive for all of ESG, impact fund managers, and markets.
Osterweis: With respect to clean energy in particular, this war has created a short-term supply shock. If someone invests in clean energy because of a short-term temporary effect, we believe they are setting themselves up for disappointment if the environment normalizes. That said, ESG has already had an impact on the energy space, but perhaps not only in the way we are discussing here. Sure, more investment has gone into clean energy, but there has also been a capital constraint on traditional energy investing. This is exactly the objective of many ESG investors who see themselves as voting with their money.
However, since oil and natural gas are commodities, the capital constraint inevitably leads to supply constraints which are more persistent and way more impactful than the short-term supply shocks from conflicts such as this one. Those supply constraints, in turn, drive the commodity prices up, again not temporarily but with a more constant upward pressure. This in turn makes inflationary pressures feel more persistent. But those higher commodity prices may also drive a better return for those who do choose to invest in that space or are already there, making them potentially more profitable and exacerbating the performance vs. progress perception.
Ultimately, such short-term catalysts tend to be counterproductive to long-term change, and while we expect there will be more awareness related to how concentrated the fossil fuel geopolitical power dynamic actually is, investors should not lose focus on the fact that making clean energy economically equivalent at all times is more long-lasting.
PekinHardy: There is no question that the disruption of global energy markets has caused investors and policymakers to rethink energy strategies. Energy markets were already under pressure prior to the Russia-Ukraine conflict, but the shutting off of Russian energy from global markets and the significant economic consequences of this disruption showed us just how fragile our current energy strategies really are. This definitely argues for some new thinking with regard to energy. This new thinking should most certainly focus on expanding the use of renewable energy sources and accelerating technological development within the renewables space in order to diversify away from more traditional energy sources. I also think it should put nuclear energy back into the spotlight as an important piece of the clean energy puzzle.