Sustainable investment and the Russian invasion of Ukraine

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Editor’s note: Read the latest on the impact of Russia’s invasion of Ukraine on the global economy and what it means for investors.

Russia’s invasion of Ukraine has sparked much discussion about sustainable investing, highlighting the growing influence of sustainability concepts on investing in general. But clarity on the terms of the discussion is badly needed.

Much of the discussion focused on values-based exclusions. But sustainable investing is much more than that, and these other areas have a greater impact on people and the planet, including addressing the issues raised by the invasion of Ukraine.

Financial materiality

First, while “ESG” is often used as an umbrella term for what we call sustainable investing, it has a narrower meaning. It generally refers to the assessment of a company’s material environmental, social and corporate governance issues. ESG metrics and ratings are used by investment analysts to assess companies more holistically, rather than simply relying on financial data. The idea that ESG concerns are financially material and therefore can impact a company’s bottom line is a core part of sustainable investing and a key reason for its rapid growth. The funds that we call “ESG funds” are generally those in which ESG analysis plays a central role. Today, most asset managers have integrated ESG analysis to some degree into their investment process.

The financial results for investors may be better returns achieved through a more thorough process, but that depends on the execution of the portfolio manager, and we all know how hard it is to beat the market.

But the broader impact of the widespread use of ESG assessments on people and the planet is significant. Investors have successfully made the case to company management that it should address ESG issues that are material to its business, with the central message being, in the words of Andrew Winston, “that the management of climate and other ESG issues is at the heart of company value”. Beyond that, Winston notes, many companies are taking “bolder systemic approaches that create a net positive impact on the world.”

One way for a company to do this is to be a responsible actor in the public arena when conditions warrant, rather than being reluctant to take a stand. As of this writing, at least 340 international companies have announced their withdrawal from Russia. It’s not just because of ESG, as other stakeholders, especially customers, employees and business partners, are clamoring for companies to leave Russia. Granted, it may not be long before the US or Russian governments or conditions on the ground dictate the issue. But what is striking is the willingness of so many companies to move forward proactively, knowing that their stakeholders, including the growing number of ESG investors, are OK for them to do it. ESG encouraged companies to listen to their stakeholders and highlighted their need to carefully protect their reputation in an era of increased transparency through social media.

Thematic focus

A second important facet of sustainable investing is its thematic focus on investing in companies that help solve environmental and social problems through new, innovative products and services. Such investments can experience short-term ups and downs, but almost certainly offer attractive long-term growth prospects.

The urgent need for a just transition to a low-carbon economy to ward off the worst effects of climate change is, of course, a key driver of sustainability-focused investing. Funds that focus on climate action or other sustainability themes differ from those that take a more general ESG approach. The former may not be as diverse and resemble sector funds, such as those focused on renewable energy.

Russia’s invasion of Ukraine highlights the urgency of switching to renewable energy. It is not only about climate change, but also more clearly than ever about ending our dependence on Russia for oil and gas, especially in Europe, because this dependence essentially finances the invasion, not to mention the other autocratic oil states.

Company commitment

A third and increasingly important facet of sustainable investing is engaging with companies around ESG issues. Through active ownership, investors communicate directly with company management and, through proxy voting, record their views on many ESG-related issues. In the engagement process, investors often include broader stakeholder perspectives as well as information about how other companies are addressing an issue.

Shareholder support for ESG-related proposals has exploded in recent years. Not so long ago, support of just 10% for a shareholder proposal was considered a “win” because it allowed the proposal to be resubmitted the following year, sometimes prompting management to take steps to resolve the problem. Today, it is not uncommon for these proposals to obtain a majority of voted shares.

Already in this year’s proxy season, two proposals won majority support. At Jack In The Box (JACK), a shareholder proposal asking the company to adopt a sustainable packaging policy passed with 95% of the vote. Unlike management, this is believed to be the highest level of support ever given to a plastics/packaging related proposal. Following the vote, the company advised Green Century Capital Management, the sustainability-focused asset manager that sponsored the resolution, that it intended to address concerns raised by shareholders.

Meanwhile, at Walt Disney (SAY), nearly 60% of the shares were voted in favor of a shareholder proposal asking the company to report on race and gender pay gaps. The proposal, tabled by another focused on sustainability asset manager, Arjuna Capital, is acting in light of allegations of gender-based wage discrimination within the company. The SEC rejected a request by management to exclude the proposal from the ballot given the ongoing class action lawsuit on the matter.

None of those votes have to do with Russia, nor do any of the hundreds of ESG-related shareholder resolutions passed this year. But in the months and years to come, you can bet that focused on sustainability investors will discuss with companies doing business in Russia and other autocratic regimes the implications for human rights and the regime’s support for their involvement.

To summarize, focused on sustainability investors have contributed to the corporate exodus from Russia, they are leading investments in renewable energy and other sustainability themes that will reduce dependence on Russian fossil fuels, and, given their recent and growing success as active owners, they have the means to engage directly with companies on why and how they do business with petrostates.

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