Is divestment really the esg answer?
Responsible investing is taking up more and more of my time at the moment. Don’t get me wrong: long-term investing institutions wish, and should wish, to invest in sustainable businesses. That makes it important to look at environmental, social and governance (“ESG”) considerations.
The difficult bit is what to do with companies which don’t tick all the boxes. One option is simply to divest and exclude, which is what fossil fuel activists, as an example, promote. (A small memo item here: the vast Norwegian sovereign wealth fund has chosen to divest from oil primarily for reasons of diversification, not for ESG reasons.)
Let us leave aside for the moment the important question of the fiduciary duty to act in the financial interest of the pension fund. The problem with divestment is that i) any ability to influence the company’s behaviour is limited, ii) the company is owned by shareholders who may not care at all about sustainability - look at Thames Water for an example. Activists will respond by saying that leopards don’t change their spots and tobacco companies, for example, are never going to stop selling tobacco, so that doesn’t matter. In my view, that is too harsh a view: even within ‘sin’ sectors, there is a huge variance in behaviours and companies change over time. It is not sufficient to simply depict companies as good or bad.
There is a growing number of ‘sustainable’ funds which exclude stocks which do not pass the relevant ESG criteria. Their claim is they can deliver equivalent returns and I do not dispute that. I prefer this approach to straight divestment, because it allows for companies to move back into the investment universe if they clean up their act. However, this approach does not avert the problem that, without being a shareholder, engagement with the company can only be limited.
The alternative approach focuses on engagement in some form. There are pressure groups (for example LAPFF within the Local Government Pension Scheme) who are undoubtedly having some positive effects by targeting quoted companies. The real challenge is to make the power of institutions’ passive holdings work when an institution cannot even threaten to sell its holdings. Here the growth of ‘tilted’ passive strategies may help, because they send a signal to the target companies without necessarily divesting completely. However, it should be noted that the cost of running a tilted strategy is several times higher than a traditional passive mandate. It is not a cost-free strategy and nor will it keep the activists off an institution’s back.
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