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MAR. 11, 2022

Doing Well by Doing Good?

ESG has been the biggest trend in fund investing of the last few years. The trend has been hot in the investment world for at least five years, in particular in Europe, but in the last two years, it has particularly accelerated.

According to a Reuters article on ESG investing trends in 2021 through November end, inflows into ESG-focused funds worldwide were a record $649 billion. This compares to $542 billion and $285 billion that flowed into these funds in 2020 and 2019, respectively, according to Refinitiv Lipper data. ESG funds now account for 10% of worldwide fund assets. The flow effect is also felt on performance, and the stocks of companies rated highly for their sustainability efforts slightly outperformed: the MSCI World ESG Leaders' Index outperformed the MSCI World Index by about 2% in 2021.

According to the same article, investors have also been more engaged and support for social and environmental proposals at the shareholder meetings of U.S. companies rose to 32% in 2021 from 27% in 2020 and from 21% in 2017.

Companies with high ESG scores tend to be in the Information Technology, Consumer Discretionary, and Healthcare sectors. It was a relatively easy task to be an ESG focused fund and make money in 2020, when the Tech and Consumer Discretionary sectors soared during the pandemic. What happens though when the style goes out of fashion? It is much more difficult to be an ESG focused fund and make money in 2022, when the only positive sector year to date, in the S&P500, is Energy, and, within Industrials, Aerospace and Defense.

Defense sell-side analysts have been approached in the last few days by ESG investors on how to conjugate an investment in the defense sector with ESG values. And while Defense companies can somehow tick the box for Environment, the challenges on the Social and on the Governance side are considerable. On the Social side, Defense companies supply military equipment that is often used unlawfully in armed conflicts and in political unrest and are associated with serious violations of international human rights. On the Governance side, the defense industry is generally considered to be among the most susceptible to corrupt behavior, as the secrecy and the high value of defense deals provide a good opportunity for the involved parties to profit.

One can argue investment in the defense industry can make sense from an ethical standpoint, supporting companies that supply the Ukrainian army: in the end, also many countries have been supplying firearms to Ukraine since the beginning of the conflict. The problem is that most defense companies do not differentiate their customers between invaders and invaded and therefore this valuation is not possible.

Maybe this war is changing the perception of what is “acceptable” from an ESG perspective, but investors need to have complete and transparent information on where their money goes. Once again, we stress the importance of due diligence, of understanding a manager’s style and values, and of knowing what’s inside a portfolio, without stopping at a label.

We thank you for your continued support.

The FAM team