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March 8, 2022

What Russia’s war means for responsible investment

The current conflict in Ukraine highlights the ethical dilemmas that arise from holding Russian government assets and the purpose of responsible investment.

By Polly Bindman

Responsible investment under fire.
Taking up arms: some responsible investors are now investing in defence stocks as a direct result of Russia’s invasion of Ukraine. (Photo by joebelanger via iStock)
  • Exposure to Russian sovereign debt in ESG funds fell sharply just before the invasion of Ukraine, to its lowest level in just under three years.
  • While investors are in the process of a hasty retreat, questions are being raised over why the inclusion of $870m worth of Russian paper in ESG funds was ever appropriate.
  • Capital Monitor spoke to investors on how they are handling the conflict and how it is shifting their understanding of responsible investment.

The atrocities unfolding in Ukraine have sparked horror and outrage across the globe. While Russia’s brutal attack on the country has crystallised a sense of injustice, it has also forced investors to manage complex moral and financial dilemmas in real time.

Such dilemmas are leading to seemingly contradictory actions. On 2 March, Skandinaviska Enskilda Banken (SEB) reversed its weapons exclusion policy to allow six of its funds to invest in companies that generate more than 5% of their revenue from the “defence” sector.

Exposure to Russia, in whatever form, is under intense scrutiny; the actions of responsible investors – those who add ESG factors into their decision-making – even more so. To get a sense of how such investors have acted since Putin started amassing troops along Ukraine’s borders, Capital Monitor assessed the activities of ESG funds with Russian sovereign debt holdings.

The picture is mixed. As of the end of January, 210 individual investors held a total of $870m Russian sovereign bond exposure in their ESG funds. On average, these holdings make up just 0.28% of ESG fixed income funds exposed to Russia, compared with 1.2% of regular fixed income funds.

However, the conflict has clearly left many investors on the back foot and hastily exiting Russian assets. Analysis of Morningstar data finds that total exposure in ESG funds fell in January by an average of 15 percentage points, to its lowest level in just under three years, although this follows a pattern of decline since late 2019 (see chart below).

Nonetheless, these asset managers had originally designated said bonds as suitable for inclusion in sustainable strategies. Hence Capital Monitor asked the 12 largest holders of Russian government debt (as of end-January) in funds that Morningstar classifies as ESG how they were responding to the unfolding events (see chart below).

Responsible investors’ response to Russia

Of the 12, three – Legal & General Investment Management, Barings and Jyske Invest – did not respond, while Morgan Stanley Investment Management declined to comment. The remaining eight offered a range of responses, with many keen to downplay the level of exposure they have within their portfolios. We have laid out a handful of those responses below.

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Rich Kushel, head of the portfolio management group for BlackRock, along with Salim Ramji, global head of iShares (part of BlackRock), provided the following statement: “In light of the Russian invasion of Ukraine, BlackRock on Monday 28 February suspended the purchase of all Russian securities in our active and index funds… [We have also] proactively advocated with our index providers to remove Russian securities from broad-based indices.” Russian securities today account for less than 0.01% of their clients’ assets, mostly in index portfolios.

BlackRock's moves are particularly illuminating, given a previous reluctance to divest from fossil fuel stocks. Asset managers often cite their lack of influence over passive investments, arguing that such strategies are there to track their chosen benchmark.

A spokesperson from UBS Asset Management highlighted its minimal exposure to Russia, with the company citing less than 1% across a "small number" of actively managed sustainable investing–focused funds. A spokesperson from GAM, which has $109bn of assets under management (AUM), said its overall exposure to Russian sovereign debt across all funds was "very limited", but provided no specific additional data.

A spokesperson from BNP Paribas Asset Management said the company was closely monitoring the situation, adding that “at this stage it is not possible to determine the future of the funds, nor their holdings, while the ongoing closure of the local market, together with the ban on foreign sales of Russian assets, precludes any divestment in the immediate term”.

Kevin Thozet, a member of the investment committee at French fund house Carmignac ($44bn AUM), told Capital Monitor that since the end of January it had adopted a “more cautious approach” to Russian securities, reducing its exposures in light of the situation.

Carmignac has since downgraded its ESG sovereign score for Russia. Thozet added that future negotiations towards peace “would lead us to reassess this downgrade, as will a further deterioration”.

NEI Investments, a Canadian fund manager with C$11bn of AUM and a primary focus on responsible investment, offloaded its Russian sovereign debt between the end of January and shortly before sanctions were imposed, said Jon Bai, the company's chief investment officer.

“At that point, there were buyers, so we were in the fortunate position,” he said. Bai explained that as human rights are a core part of NEI Investments’ ESG approach, the company already has in place a clear protocol for handling investments in regimes with possible human rights violations.

For example, its starting principle was that “this act of war was a clear violation of the rule-based international order”, and therefore the company’s objective, via economic sanctions, has been to reduce Russia’s military operations and put an end to the war.

NEI Investments released a statement on 7 March confirming that, as of 3 March, it had zero exposure to Russian sovereign debt or currency and less than 1% exposure (three equity holdings) in its NEI Emerging Markets fund.

Divesting after the fact

Just how proactive investors can, or should be, in this situation, depends on their understanding of the meaning of responsible investment.

For investment consultant Wolfgang Kuhn, the principle is simple: “You shouldn't be a responsible investor just because it makes you money. That misses the point.”

Kuhn argues that we don't even need to talk about certain things making sense financially because it's self-evident. “We need to talk about the things that don't make financial sense, possibly in the short term.”

Indeed, the hostility of Putin’s regime had been evident long before the current conflict, such as with the Russian military’s 2014 annexation of Crimea. This begs the question of whether Russian sovereign bonds ever deserved the ESG stamp of approval.

“In light of current events, it is clearly unacceptable that Russian sovereign bonds should be listed in ESG funds," says Peter Uhlenbruch, director of financial sector strategies at ShareAction, a charity that promotes responsible investment. "But given that Russia was already under international sanctions for its annexation of Crimea, it is legitimate to ask why these bonds were in ESG funds in the first place.”

Uhlenbruch points to ShareAction’s research, which found that in 2020 just 16% of the world’s largest 75 asset managers had made firm commitments to exclude across their portfolios sovereign bonds issued by countries that were under international sanctions or involved in human rights violations. Russia was under sanctions at the time.

“This is clearly unacceptable, and the lack of investment policy guidelines on this topic means investors are often caught on the back foot and divesting after the fact," he adds. "It’s critical that asset managers articulate clear and portfolio-wide commitments on these matters and take a more proactive approach not just for ESG funds but all funds under management.”

Ethical shades of grey

But where cases are less clear cut, where should responsible investors draw the line when it comes to human rights violations, beyond brazen breaches of internationally recognised norms? For example, what about investing in the US, where capital punishment is practised?

Kuhn believes a nuanced approach is needed. “Rather than saying we exclude, or we don't exclude, I think the next step of sustainable finance should be about quantifying how many basis points you're willing to sacrifice for something more sustainable… If you want to go in the right direction, then we need to deal with these things that are not win-win or lose-lose, but shades of grey.”

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