A money manager who caters to wealthy investors has gone out of his way to shield them from the long-standing risks he says have made the banking sector incompatible with the concept of sustainable investing.

Chat Reynders, who runs Reynders McVeigh Capital Management, a $3.5 billion sustainable investment firm in Boston, said he’s long shunned banks after judging that they’re generally incentivized to tolerate risks that other industries don’t take, often at the expense of their fiduciary duties.

There’s a “very bad incentive mismatch and the potential for real trouble,” he said in an interview. For that reason, “we’re underweight in financials just as we’re underweight in energy.”

Reynders’s long-held view on banks is starting to resonate with other ESG fund managers, after the sector lurched into its biggest crisis since the financial meltdown of 2008. Investors now find themselves wondering how well bank stocks fit with the environmental, social and good governance goals that ESG is supposed to target.

“Sustainability isn’t just the environment, it’s about what’s in the business model, how are you managing your business,” Reynders said.

It’s an approach that’s backed up by one of the chief architects of ESG. Paul Clements-Hunt, who led a United Nations group that coined the acronym in 2004, said ESG only makes sense when all three letters of the trinity are included in the financial analysis.

“Siloed analysis of E and S and G undermines the original intentions of E-S-G,” he said. “G is critical and anchors E and S.”

For Daniel Wild, a former head of ESG strategy at Credit Suisse Group AG who’s now the chief sustainability officer at J. Safra Sarasin, a key takeaway of the turbulence currently gripping bank stocks is the need for ESG investors to monitor governance risks more attentively.

“It certainly underlines how important the G is in ESG,” he said. Neglecting governance “a little bit in recent years” was “not a complete mistake,” he also said. “We have urgent problems related to climate, related to biodiversity. But without the G it doesn’t work either.”

Sonia Kowal, who runs one of the oldest socially responsible investing funds, also pointed to the higher governance risks involved in banking, saying the companies’ incentive structures aren’t aligned with good oversight.

“We find that many major money center banks, especially in the US, engage in financing activities that can lead to elevated investor and systemic risks, including those of an ESG nature,” said Kowal, president of Zevin Asset Management in Boston.

Comparing the Numbers
Because it avoids fossil fuels, the Reynders McVeigh Core Equity Fund has missed out on gains fanned by last year’s energy crisis. But since its start in early 2019, the fund has returned almost 54%. That compares with the 37% gain of its benchmark, the MSCI World Index, and a drop of about 5% for the KBW Bank Index. All the performance numbers include reinvested dividends.

Reynder’s portfolio also has done better than the almost 47% gain in the world’s biggest ESG exchange-traded fund — BlackRock Inc.’s ESG Aware MSCI USA ETF.

Meanwhile, hundreds of other ESG funds have been dragged into the spiral of losses triggered first by the failure of Silicon Valley Bank in the US and the implosion of Credit Suisse in Europe.

Over 160 funds that under European rules either claim to “promote” ESG or make it their outright “objective” — as well as funds just marketing themselves under the label — hold roughly 52 million Credit Suisse shares in total, according to Bloomberg data based on the latest available filings through March 15. Some of those funds even ratcheted up their exposure to the troubled Swiss bank in recent months.

Well over 900 ESG funds were exposed to the now collapsed Silicon Valley Bank, Bloomberg data show. That raises serious questions about the attention that ESG fund managers have been paying to good governance, according to an analysis by BloombergNEF.

In all, financials excluding insurance make up about 9% of assets held by ESG funds, according to data compiled by Bloomberg. That compares with a roughly 15% exposure to technology stocks and 11% to the health-care sector.

Banks in general are struggling to adapt to the much higher interest-rate environment that followed the pandemic. Though it’s now clear that not all have been making the necessary adjustments, investors weren’t always in a position to detect many of those risks before it was too late. That’s especially true if auditors provided a clean bill of health and regulators weren’t monitoring brewing risks.

Reynders said investors couldn’t assume banks were much safer as a result of stricter rules imposed after the financial crisis of 2008, when capital requirements were yanked up.

“These bank failures we see aren’t a matter of the system not being capitalized as well as it should be,” he said. “In Credit Suisse’s case it’s really bad quality loans that they’ve had for a long time. In SVB’s case, it’s a mismatch.”

--With assistance from Amine Haddaoui and Carlo Maccioni.

This article was provided by Bloomberg News.