A M109 155mm self-propelled howitzer at a position in the Donetsk region. Photographer: Anatoli Stepanov/AFP/Getty Images
FRANKFURT: In the world’s biggest environmental, social and governance (ESG) fund class, portfolio managers are getting more comfortable with holding military assets against a backdrop of mounting political pressure and industry profits.
At the end of the third quarter, 1,238 funds claiming to “promote” ESG goals held stocks in the industry classification code aerospace and defence, according to Morningstar Inc data.
That’s roughly 25% more than in March last year, right after Russia invaded Ukraine. A large portion of those funds converted to “ESG” during the period, Morningstar said.
The development is playing out amid a campaign to get ESG investors to support Europe’s military capability, as geopolitics in the wider region become increasingly fraught.
Alexander Stafford, chair of the UK All-Party Parliamentary Group on ESG, told Bloomberg that “the violence” that’s followed the invasion of Ukraine has cemented to me the ESG case for defence-related investment.”
And within military circles, investing in weapons is being held up as the ethical thing to do.
Last month, North Atlantic Treaty Organisation secretary-general Jens Stoltenberg called for more money to be allocated to weapons, arguing that there’s “nothing unethical about defending our freedom.”
Yet the issue continues to divide ESG investors. And the war between Israel and Hamas has underlined what’s at stake, as the world looks on in horror at the growing list of civilian fatalities.
“Identifying whether investments are being deployed for defence or aggression is a very difficult due diligence to undertake,” said Sonali Siriwardena, global head of ESG at law firm Simmons & Simmons.
Ultimately, “it’s a question of how do you ensure that these investments are being used for a defensive purpose as opposed to indirectly contributing to offensive action.”
Sasja Beslik, chief investment strategy officer at SDG Impact Japan, said it’s hard to claim that investments in defence are aligned with the United Nations’ 16th Sustainable Development Goal, which targets peace, justice and strong institutions.
“I have no problem with people investing in weapons companies or stock, but don’t do it under the sort of umbrella of ESG or sustainability, because it’s not,” he said. “These are products that kill people.”
While the world’s largest ESG fund class is more exposed to defence assets now than in March 2022, it’s a different picture in other corners of the industry.
In the European Union’s smallest – and strictest – ESG classification (known as article nine), funds are retreating from defence assets.
And among funds that claim to be “promoting” ESG – known as article eight – the rise in exposure to defence stocks still only leaves such holdings at 0.44% of total assets, which Morningstar puts at about US$5 trillion.
Morningstar also points out that much of the increase in the number of article eight funds holding defence assets comes after the fund class absorbed a wave of upgrades from a non-ESG fund portfolio category known as article six.
James Penny, chief investment officer at TAM Asset Management and an ESG investing veteran, said the issue remains “very difficult.”
“On the margin, I would still agree with the assertion that these aren’t ESG companies and I’d feel quite comfortable putting that into our portfolios as a red line,” he said.
Jens Munch Holst, chief executive at Danish pension fund AkademikerPension, said his red line starts at producers of controversial weapons, such as cluster munitions and nuclear arms.
But after that, the fund is open to investing in defence companies that demonstrate good governance and good returns, he said.
AkademikerPension holds SAAB AB, which makes the Gripen fighter jet, and Kongsberg Gruppen, which recently sold a coastal missile system to Poland to help it bolster its defences against Russia.
“The defence industry lives fine without our investments,” he said.
“We don’t think it’s credible that we would be able to influence them on the products they sell, and especially when it comes to nuclear weapons.” — Bloomberg
