Week 9: A historic ESG blunder and why we must start looking at China

In this issue: ▸ We knew it, but did not act ▸ How have banks and asset managers reacted? ▸ US lawmakers threaten divestment legislation ▸ And much more...

Dear all,

Divest, exclude, freeze, re-asses, blacklist. These words are flying through the thick air while the bombs are falling down on the Ukrainian people.

Now that the tanks have rolled in and people are dying every day in the country that has been calling for help since 2014, we have come to our senses and we act. Or react, rather, and too late.

We knew it, but did not act

How could we not know? I mean we’re talking about the most informed industry in the world that can calculate the margin of a square meter of a hotel room rented on an hourly basis including discount rate for people that would stay only 1 hour including their age profile and preferences as well as geographic price models.

The information we needed to act responsibly in relation to what is happening right now was sitting right in front of us, all the time. But our task has never been to be the “moral police”, someone in the financial industry uttered in one of the gazillion interviews about what is happening in Ukraine.

Let’s stay there for a second. This has nothing to do with morals. The promise of ESG is to manage the down and upside of risks and opportunities associated with the investments we make on behalf of our clients, including where they operate.

The sanctions by the UN, EU or US imposed on bad actors such as Sudan and North Korea were followed by everyone. But hitting Russia and Russian associated investments after 2014, despite the sanctions in place, was never really even discussed. 

The information flows from our we-cover-all-of-it-for-you ESG data suppliers since 2014 do not include warnings on stock level such as “company derives % of its revenues from UN/US/EU sanctioned country” or  “this company has production, sales and distribution in the country that has invaded other sovereign countries twice in last 10 years.”

That is one side of it. The other side is our own so-called ESG analysis, and people on that side of the business sort of lost track on why they are there in the first place. Let me be clear: It’s not to be complacent, or to be loved by portfolio managers, or to make sure that the board and the CEO respect their knowledge. 

The role of ESG professionals has never been so important, yet never so marginalised as it is today. Reason? Today, ESG is just business, integrated, part of the crew, part of this ship’s feature. It has lost its true intent. Today, ESG is about having a career, about being a respected member of financial community, about participating in conferences, giving speeches. It is no longer about changing the financial toolbox, about challenging the blindness of an industry for which externalities is something taxpayers will pay. No, it’s about selling mediocre and – most of the time – useless ESG funds and investments.

Sadly, it is no longer about being a pain in the arse, raising questions about “why do we invest in a company when they operate their business like this?” or “why do we invest in Russia or China when we know what is going on there?”

Today, we have committees, of various shapes and kinds, and when you can’t make a call on a investment that really doesn’t make sense then you bring it to a committee run by “real investment guys”, and then they make a committee decision that investments in Russia or China are completely fine and that engagement is the best course of action.

If someone would have said to the financial community just three weeks ago that we will shut down investments for the entire country of Russia, they would have had a real good laugh.

The tragedy playing out in Ukraine, beside all the atrocities committed against the population in Ukraine, is also a warning signal for all of us working with ESG in the financial industry. We knew Russia invaded Ukraine in 2014 and occupied Crimea, we knew it and most of us did nothing. Investments continued flowing and we continued showing how ESG can “add value” and can be linked to the SDGs. It is just sad. 

How have banks and asset managers reacted?

It’s now water under the bridge, as they say (while the Ukrainian people struggle for their physical survival). We have learned now that we have failed and that we should do better next time.

But what is “next time”? Well, it could very well turn out to be China, and the Dragon in the East is a far more complex creature to handle.

But before we go into all of that, today we will take a look at how various players have reacted on Russia’s “special situation”. Not war. Some banks and asset managers have issued internal warnings to staff not to use word “war” when referring to the war Russia is waging against Ukraine.

“Use the term “conflict” instead if you really have to go there. We don’t want to offend our clients and potential clients and future business relationships.”

At the same time, same asset managers and banks give ridiculously, laughable small amounts of money to NGOs and post about it on social media. It’s disgusting. 

The losses suffered by the Russian stock market and the Russian companies listed on the Western exchanges have been dramatic. By midday on Wednesday, Sberbank’s price on the London Stock Exchange collapsed by 91%, while Rosneft was down 66% and Gazprom was down 30%.

On Monday, the Financial Times reported that Russia’s largest sovereign bond – a $7bn note maturing 2047 – was selling for 33 cents on the dollar after a junk downgrade from S&P.

In as much as anyone in this conflict can be a winner, those investors who have reduced their holdings over the past months or had previously divested on ethical grounds will emerge from the sell-off largely unscathed. Among these investors is the UK’s BT Pension Scheme, which began to sell down its Russian assets at the end of 2021, reducing a £192m position to £30m by the end of February.

A spokesperson for the fund said it would look to reduce this position further if market conditions allow. Similarly, British Columbia Investments began to sell out before the invasion, and has been left with C$107m (€78m) in Russian equities. Gordon J. Fyfe, its CEO/CIO said: “We don’t normally comment publicly on our investment activities, however given the egregious actions of Russia it is important to make an exception”.

While the invasion of Ukraine has finally crossed a line for many investors – a spokesperson for Legal & General Investment Management (LGIM) said it contravened “almost every measurable ESG metric” – a number of investors had long ditched their Russia holdings. CPP Investments, Canada’s largest pension fund, said that it made a conscious decision “years ago” not to have Russia as one of its markets, while Sweden’s Alecta said that it didn’t invest in “government debt issued by states that systematically and seriously violate human rights or where corruption is widespread”.

Among the biggest financial losers will be Norway’s sovereign wealth fund. The fund watched as Russian holdings worth NOK27.4bn (€2.8bn) at the end of last year shrank in value to NOK16.5bn two days after the invasion. It decided to sit still, but has now been ordered by the government to offload its stake, which it estimated was worth just NOK2.5bn as of the 2nd of March. Similarly, ABP has €520m of holdings to sell, while Storebrand will sell NOK1.4bn (€132m) of holdings in 19 Russian companies as soon as possible “subject to market disruption”.

Japan’s Government Pension Fund, the world’s largest, told RI it was not allowed to make investment decisions for political reasons, although it is reviewing its ¥220bn (€1.7bn) Russia-linked assets from a risk perspective.

DNB Asset Management announced it would sell all Russian shares, and put its “index on freeze.” The Norwegian investor has had a “strict criteria” for investing in Russia since 2014; this has meant – amongst other things – it has avoided Russian banks such as Sberbank and VTB, and corporations including Rosneft and Gazprom. Other asset managers have also been left with large holdings in Russia.

Abdrn said that it had been reducing its exposure since the start of the year, but still has £2bn in holdings – around 0.5% of its AUM. LGIM said it has reduced client exposure to Russia “where possible,” and its total exposure now stands at 0.1% of AUM, or £1.3bn, mostly in index funds and ETFs where it cannot be reduced without index changes.

NN Investment Partners’ 2022 emerging markets debt outlook said that it viewed the possibility of a Russia-Ukraine conflict as “low” and that it remained overweight both Russia and Ukraine. The asset manager had, as of September 30 2022, more than $120 million in Russian sovereign bonds. A spokesperson did not respond to a request for comment on whether the manager had maintained its weightings.

US lawmakers threaten divestment legislation

In the US, state pension funds are acting more cautiously, although some are facing divestment bills introduced by lawmakers. CalPERS has around $1bn invested in Russia across public and private equity and real estate, while CalSTRS had Russian investments worth $500m as of February 23rd. Neither fund has committed to divesting Russian assets, but both could be forced to ditch their holdings, as state lawmakers plan to introduce a bill mandating divestment.

California governor Gavin Newsom has also written to the two funds, calling on them to make no new investments in Russia and to assess the risk to fund members posed by their Russian holdings. CalPERS Board President Theresa Taylor responded to the letter, saying that the fund had frozen new investment into the country, and was assessing its real estate investments.

Spokespersons for state pension funds in Virginia, Florida, Oregon and Alaska all told RI that they were reviewing their investments, but made no commitments to divest, while of the five New York City pension funds only the police and public employee funds have voted to divest, ditching $42.2m and $31.1m holdings respectively.

Connecticut and Rhode Island have both directed their pension funds to divest. As in California, lawmakers in Georgia, Pennsylvania and Massachusetts have said they will introduce legislation to force pension fund divestment, and New York State Comptroller Thomas DiNapoli has directed the state’s pension funds to stop all new investments in Russia and review their current $110.8m equity holdings for potential financial risks which would require divestment.

Investors are also unable to recover their money from a number of funds, with half a dozen managers including JP Morgan, UBS and Pictet Asset Management freezing withdrawals from funds with high exposure to Russia. With this in mind, some investors have said that there is little point making a divestment commitment now.

A spokesperson for Dutch manager PGGM, which holds €1.2bn in equity and sovereign bonds – mainly on behalf of healthcare pension fund PFZW – said that “market circumstances and sanctions make selling hardly an option right now”, and that trustees were looking at reducing investments in the long run.

Other investors have cautioned that their divestments will be subject to market conditions. This may mean divestment over a period of months, although slower divestments may carry reputational risk. The other problem is finding a buyer. With western investors in full retreat, and managers unable to buy some shares due to sanctions, it may fall to investors in Asia to pick up the stocks, although with markets as turbulent as they currently are, and the long term impacts of sanctions unclear, Russian companies are not a particularly attractive investment.

A spokesperson for Singapore’s sovereign wealth fund Temasek said that it had no active investments in Russia or Ukraine, for example.

A second source of buyers could come from the retail market. While retail investors may lack the financial weight to relieve larger institutional investors of their stakes, there are already indications of significant retail interest in dirt cheap Russian stocks on the London Stock Exchange.

Shares in Russian gold miner Polymetal International, Russia-exposed miner Evraz and Eurasia Mining are among the top ten traded shares on popular UK retail platforms Hargreaves Lansdown and AJ Bell, while BlackRock has increased its stake in Polymetal by 0.3%. Shares in the company are down 71% over the past week, with Evraz down 69% and both firms facing ejection from the FTSE 100.

For some market participants divestment is inevitable, “I certainly think investors should divest, because if they don’t they are complicit, and if they think engagement can yield any results in this situation, they are either naive or dishonest (in which case engagement is merely a delaying tactic). When you put the two together, I see no other option.” 

Read much more on Responsible Investor here:

And for all the ESG investors out there, this is a good list to start with in relation to next big thing. And this time we cannot say “We did not know.” 

Kind regards,
Sasja