Charles Stanley: Should ESG apply to governments as well as companies?

Charities are under pressure to take socially aware investing seriously. Many charities have been early adopters of the new tools to evaluate share portfolios under the ESG banner.

Investment managers can now tell charities how their share portfolios rate on a series of measures designed to illustrate how well governed companies are, how green they are and how well they treat their employees and neighbours. Investment professionals can help Boards and Committees draw up an appropriate ESG policy that will also allow good investment decisions.

This is leading to debates in investment committees and Boards over whether it is better to confine investment to good ESG performers, or whether to also invest in improvers. Should a portfolio ban investment in fossil fuel companies, or should it invest in them as many of them are themselves drivers of the green transition, making substantial investment in alternatives to their historic activities? Should a Committee rule out a whole industry, or invest in the best governed companies within the more difficult areas?

Studies have revealed that there are many judgements in these matters, including in how to construct and compile the data.  There are few absolutes and no perfect portfolio of saintly companies. Charities also need to be aware of their legal duties and to seek guidance on what they can include in an ESG strategy. They still need to maximise returns for an agreed level of risk, though they can probably ban investment in sectors or shares that clearly conflict with the aims of the charity. Extending too many bans might start to impede investment choice and potential returns. A charity Trustee can help the charity form a good policy to show the charity has thought through the issues but is not entitled to reproduce all their personal preferences and dislikes as an investment strategy.

One of the less discussed questions is whether ESG rankings and policy should also extend to governments as well as to companies. If a charity wishes to ban investments in aggressive weapons, it is usually permissible to do so. The charity still needs to define what they are and what proportion of a company’s revenues comes from such activity, as many other companies may generate some revenue from providing banking, legal, media and other services to an arms manufacturer. The governments of course are the main arms buyers and users, so investing in their debt is also financing the arms trade. Banning such investment is usually ruled out on the grounds that the arms spending of the government is usually a small single figure percentage of the total.

It may be that a Charity keen to limit the use of arms does need to look at those governments which are accused of overuse or abuse of weapons and violence. The Western governments seek to regulate the arms trade in their own jurisdiction, placing bans on the sale of certain weapons to third countries where they cannot be trusted to restrain and control use properly. This approach may also be suitable for a charity investor. What though should we make of governments that do not behave to western standards over matters like free speech, civil liberties, conditions of employment, treatment of minorities, harbouring of terrorists and permitting disruptive behaviours? Maybe a charity fund should not invest in the debt of a country which behaves badly. Maybe charities should be careful about equity investment into companies in such countries where co ownership by the state or intense regulatory supervision of the company makes them a creature of the government.

In the green area, should we differentiate between countries that are energetically pursuing the reduction of carbon and those who are not? It is by general agreement a case that the green transition needs to be led by government. Governments need to use a range of tools from subsidy and bans through regulations to joint ventures and direct state investment to effect change from fossil fuel-based systems to renewable and electric ones. Backing investment in countries that have not yet agreed to stop the rise in their carbon dioxide output, let alone reverse it becomes more contentious as pressure mounts on world governments to respond positively to the international environmental treaty framework.

There is no substitute for a good discussion of these difficult issues around the Trustee table. Trustees need to know more about what range of investment options there are to reflect their general approach. There will be compromise involved, as many companies span good and bad and have diverse turnover. Many countries are subject to criticism for their actions or inactions. It is best to have clear principles and to seek to make judgements and decisions based on hard data wherever possible.

John Redwood, Chief Global Strategist – Charles Stanley