ESG Managers Skewer ‘Ridiculous’ Idea of Embracing Arms Stocks
(Bloomberg) -- There’s a group of fund managers overseeing environmental, social and governance investments who worry their field is facing another blow to its credibility.
Since the arrival of war in Europe, arms lobbyists, financial analysts and some bankers have been discussing the merits of treating weapons as ESG assets. And with lawmakers in Europe now facing pressure to add defense companies to the bloc’s environmental, social and governance rulebook, critics are asking whether the label risks losing all meaning.
“If we were talking about this two years ago, people would be laughing at us saying how ridiculous that you put a defense stock in an ESG portfolio,” said James Penny, chief investment officer at TAM Asset Management, a London-based firm that’s been running ESG portfolios for almost a decade.
It’s the latest in a series of awkward moments for the $40 trillion ESG industry. Sasja Beslik, an ESG expert and author of “Where the Money Tree Grows,” has called the weapons debate “appalling.” The EMEA head of ESG research at UBS Investment Bank, Vicki Kalb, dismissed it as “emotional,” while ESG data cruncher Util said the idea of allowing defense companies to be deemed sustainable assets is misguided.
Some ESG classifications were already starting to look shady before the deliberation about weapons, said Eric Pedersen, the head of responsible investments at Nordea Asset Management. Importantly, Europe’s decision to give gas and nuclear energy a “green” label signaled that rule makers were opening the door to more ESG contortions, he said.
Without “the precedent of gas and nuclear, everybody would have said: Weapons in the social taxonomy? You must be dreaming,” according to Pedersen.
It’s part of a wider “problem right now with ESG,” said Penny, referring to the defense industry. “A topic that was widely outlawed a year ago is now suddenly potentially ESG-appropriate.”
In a survey by Bfinance published Monday, 39% of investors said “recent geopolitical developments” were grounds for adjusting their approach to ESG. Among areas investors said needed to be reviewed were exposures to emerging markets, controversial weapons and fossil-fuel companies.
Beslik, who fled Bosnia as a war refugee when he was 19 and now oversees sustainable investing at Danish pension fund PFA, said he’s convinced weapons “don’t belong in the ESG space at all.”
Yet some ESG investing clients are being advised to take another look at weapons. In a March note, analysts at Citigroup Inc. said there’s a good likelihood weapons will make it into the next chapter of Europe’s ESG rulebook, known as the social taxonomy. In light of the war, the European Union looks set to define the arms business as crucial to “maintaining peace, stability and social goods,” they wrote.
In a similar vein, analysts at Jefferies said ESG clients who have historically avoided defense companies may shift course as regulators take another look.
Read more: Ukraine War May Drive Defense’s ESG Inclusion: Citi, Jefferies
In a policy paper published in February, the European Commission said it’s important that “initiatives on sustainable finance remain consistent with the European Union efforts to facilitate the European defense industry’s sufficient access to finance and investment.”
The notion that weapons might be treated as ESG assets took off after Russia’s invasion of Ukraine. Arming Ukraine is now the West’s most urgent strategy to help protect the country from Vladimir Putin’s invasion, turning the weapons provided into tools for defending democracy.
Desiree Fixler, a former DWS Group sustainability head turned ESG whistleblower, said in a recent panel hosted by Bloomberg Intelligence that “Ukraine raises the question of ‘what is ESG.’” As to the issue of whether defense stocks are good or bad, she said again that “war raises so many questions.”
Defense companies’ evolving status within ESG has coincided with significant gains in the share prices of a number of major arms producers. Rheinmetall AG, a German manufacturer of military equipment, has almost doubled in value since the Feb. 24 invasion.
According to Penny, the sudden outperformance of defense stocks has prompted some investors to ask why they’re not being included in ESG portfolios. But that kind of reasoning “undermines the whole ESG movement,” he said.
There are already some parts of Europe’s ESG rulebook that make room for defense stocks, including so-called Article 8 funds, which are supposed to promote overall ESG characteristics. There’s about $3.5 billion of investments listed as aerospace and defense parked in such funds, according to data compiled by Bloomberg.
Pedersen said Article 8 funds at Nordea “can hold” defense stocks, though a host of additional exclusions still apply, including a ban on all nuclear and controversial weapons. He said it’s hard to imagine weapons making it into the stricter ESG fund category known as Article 9.
Kiran Aziz, head of responsible investments at Oslo-based pension firm KLP, said she only considers defense stocks if manufacturers can prove their products aren’t being used in illegal conflicts, meaning KLP excludes companies found to be tainted by “serious and systematic breaches to international law.”
But such conditions can be hard to enforce, according to Herve Guez, Mirova’s chief investment officer. “Arms makers have no means to pick their clients and refuse contracts with undemocratic regimes,” he said.
There’s an obvious argument to be made for investing in weapons, but there’s no case for calling such investments sustainable, Beslik said. Ultimately, presenting the debate as something “that the ESG community has to look at” seems “quite crazy,” he said.
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