War Jolts ESG Funds That Waited Too Long to Unload Russia Assets

(Bloomberg) -- The same morning Russia invaded Ukraine, the people running the Church of England's $5 billion pension fund decided they'd seen enough, and quickly went to work to clear their portfolio of Russian investments.

At that point, there were still buyers. By March 1, they'd unwound their entire 8 million-pound ($11 million) stake.

Few were so lucky. Most funds — including those screening for environmental, social and governance factors — failed to see the risks that a Russian invasion of Ukraine could pose to their portfolios. As the losses and economic fallout mount, asset managers are increasingly calling the war a clarifying moment for ESG in the industry.

Too many investors have been blind to the idea that ethical investing ultimately has the potential to protect wealth, said Adam Matthews, chief responsible investment officer for the Church of England Pensions Board. The perceived division between "hard-nosed finance" and "morality" is false, he said. “It's possible — and important — to think about both aspects.”

When a country violates “international norms and invades another sovereign country, then it is clearly an ethical and moral issue that has financial impact," Matthews said.

Since President Vladimir Putin plunged the European continent into its worst military conflict since World War II, a growing number of fund managers and corporate bosses are being forced to consider whether conscientious imperatives, or politics, should guide their investment decisions.

BP Plc, for example, has owned a stake in Rosneft PJSC for about a decade, unmoved by investors' concerns about the Russian energy explorer's environmental track record. This week, however, the U.K. government pressured BP to sell the holding because of the unacceptable social ramifications tied to Russia's invasion of Ukraine.

In Norway, the head of the country's $1.3 trillion sovereign wealth fund said he had no intention of selling Russian assets worth roughly $3 billion — until the government said the “brutal war of aggression against Ukraine from Russia” demanded the holding be frozen and divested.

The lesson for ESG investors is to “act before war breaks out and not to be afraid to denounce, and divest from companies and countries which are serial human rights violators,” said Kiran Aziz, head of responsible investment at KLP, Norway's largest pension fund. “Knowing international law, whilst moving first and fast, can be highly effective as it creates a domino effect.”

Some large investment firms with big ESG ambitions are just now taking steps to distance themselves from Putin's regime. DWS Group, which is about 80% owned by Deutsche Bank AG, said Tuesday that its actively managed mutual funds won't make new investments in Russian securities “until further notice," and it will “suspend the subscription of new shares” in mutual funds that have significant Russian exposure.

“This war of aggression hasn't only undermined trust between the Russian government and the Western world, but will also permanently change Europe's security architecture, energy policy, and create significant volatility,” the company said in a statement.

In an interview with Politico, Fiona Hill, who served as U.S. National Security Council senior director for Russian and European Affairs during the Trump administration, said the current conflict is a crucial moment for anyone who cares how their money is being used in the world.

“Just like people didn't want their money invested in South Africa during apartheid, do you really want to have your money invested in Russia during Russia's brutal invasion and subjugation and carving up of Ukraine?” she said.

“If Western companies, their pension plans or mutual funds, are invested in Russia, they should pull out,” Hill said. “Any people who are sitting on the boards of major Russian companies should resign immediately.”

What's happening in Ukraine has the potential to cause major adjustments in an industry that's often taken a pragmatic approach when dealing with markets run by dictators and autocrats. That includes so-called ESG funds, which are supposed to have a lower tolerance for investments that carry environmental, social or governance risks.

But for many, that didn't exclude Russian companies. About 14% of sustainable investment funds are directly exposed to Russia, according to industry research firm Morningstar Inc. At the end of last year, ESG funds were invested in Gazprom PJSC, Lukoil PJSC and Rosneft, among others.

Abrdn Plc Chief Executive Officer Stephen Bird said Tuesday that his firm was trying to exit its 5 million-pound holding of Russian assets “on ESG grounds.” However, the nation's financial markets are frozen, making it virtually impossible to find buyers.

Not everyone sees the moral imperative the same way. For now, Abu Dhabi's Mubadala Investment Co. and Qatar Investment Authority are planning to hold on to Russian assets worth billions of dollars, which they view as strategic, long-term investments, people familiar with the matter said. The QIA, which has a roughly 19% stake in Rosneft, sees that investment as key to supporting Doha's relationship with Moscow, the people said.

“It's part of a broader attempt by Gulf states to continue working with Russia where there are mutual interests,” said Rachel Ziemba, the New York-based founder of the advisory firm Ziemba Insights. “They are trying to balance the risk of secondary sanctions with long-term relationships.”