Recently there has been some discussion around whether ESG poses a threat to the armaments industry, effectively criticising funds with related exclusions. Although difficult, not least because views vary on what constitutes ‘defence’, this is an interesting and long-standing topic.
One of the aspects that concerns me most about today’s debate is the apparent disregard for differences in opinion (not uncommon these days!), so I will briefly explore how and why different ESG, sustainable, responsible and ethical funds deal with the topic, in the hope of helping to bridge the emerging chasm.
Starting with the basics, fund strategies vary because people have different financial aims and personal preferences. The fund industry responds to these, balancing them in different ways to suit different clients.
Some key approaches to investment in the defence sector include:
- ESG ‘financial risk’-based avoidance, where some or all armaments companies – and/or their suppliers – are not held because they fail environmental, social and/or governance-related data screens, meaning they are deemed unattractive because they carry unacceptable risks. Such funds are typically regarded as focusing on ESG.
- Values-led exclusions, where funds have explicit armaments-related policy exclusions. These funds publish exclusion policies that set out specifically what the fund will not invest in. Some exclude only manufacturers of strategic weapons systems, others extend that to non-strategic products (eg safety equipment) and third-party suppliers of generic products that nonetheless are enablers of military operations. These funds are typically promoted as ‘ethical’ or ‘sustainable’. Amending those policies is difficult as it would require contacting clients, risking complaints and potentially leading to significant fund outflows.
- Norms-based exclusions, where exclusions are based on UN conventions and international agreements that oppose weapons causing ‘unacceptable suffering’, such as cluster munitions, land mines and white phosphorus. Such exclusions are common across the investment spectrum, with some asset managers having ‘controversial weapons’ screens across all assets.
Risk management, norms and values-led criteria often overlap and are regularly combined in individual fund strategies. From both an ‘ethical’ and an investment management perspective these companies represent risks both because of what they do and how they operate. Their (understandable) lack of transparency is not something funds focused on risk management warm to.
From a client perspective, not everyone will care, but others will have strong views – both ‘for’ or ‘against’ investment in this area. Opinions on the defence sector vary and are often deeply held – often shaped by lived experience, real-world events and faith. Indeed, as we see, what one person regards as defence can be seen as unjustifiable by another. And it is too easy (particularly in the UK) to gloss over the fact we rely on the military to defend us if things go badly wrong.
Gilt markets
Such debates also spill into gilt markets. Whether or not gilts are ‘ethical’ is a debate as old as ethical investment itself (Stewardship, the first UK fund range, excluded them). The reality is that opinions vary, and free markets can cater for diverse views. So today some sustainable and ethical funds hold gilts – while others do not.
Our Fund EcoMarket database lists 31 primary funds that ‘exclude all gilts’ and 58 that ‘exclude some gilts’. There are also 335 funds that ‘exclude armaments manufacturers’, indicating that direct investment in arms companies is a greater concern than investing in those that purchase their products.
We also list 534 funds that are run by management groups that exclude controversial weapons across all of their funds.
Opinions differ
Avoidance of armaments manufacturers ranges across all ‘SRI’-style classifications and that is unlikely to change. Indeed the first ethical funds were deeply opposed to investment in the arms sector. The first US ethical fund was launched for those opposed to the Vietnam War, and the first UK fund had its roots in pacifism – with its Quaker and Methodist origins.
However, where we are today should be front and centre. Russia’s invasion of Ukraine and the horrors in Israel and Gaza have brought this into sharp focus. The world certainly feels like a scarier place than it did a few years ago.
The importance of ‘defence’ may therefore have shifted for some, although opposition to the use of internationally condemned weapons and selling weapons to abusers of human rights is unlikely to abate. The fact defence sector shares have risen significantly recently should however put any concerns about potential underinvestment risks into perspective.
So as our hearts go out to those in distress – and in some cases our spare rooms do also – we should also look to the future. Although there is much positive progress and innovation taking place around the world we are still collectively failing to get to grips with global warming. It is hard to imagine how conflicts would not increase resources become more scarce.
There may be little we can do to end today’s conflicts (I doubt shareholders engaging with companies would help). But we absolutely can, and must, move heaven and earth to drive down fossil fuel extraction, dispel myths about unproven technologies and finance the necessary transition. All of this is firmly within our collective skill sets, responsibilities – and grasp.