Source: Eurostat. Data as of December 31, 2020.
The continued dependence on fossil fuels has left countries and companies exposed to geopolitical risk, underscoring the need for a resilient infrastructure that can withstand shocks and volatility as we are seeing in the Ukraine today. This will likely cause an increase in spending to improve grid resiliency and diversify energy sources with an acceleration in green energy investment as these options become more price competitive. We are already seeing signs of this, with the European Commission’s release of its REPowerEU plan to make the EU independent from Russian fossil fuels “well before 2030,” presenting an opportunity for European utility companies with existing renewable energy exposure.
As the conflict evolves, we are growing more cautious of companies that are both overexposed to fossil fuels and lack alternative sources of energy. Overreliance on hydrocarbons will likely lead to years of costly investment as they seek to diversify their energy sources and upgrade their infrastructure in line with energy efficiency standards. Alongside any companies with significant operations in Eastern Europe, the key sectors and industries that will be impacted are automobiles, energy, utilities, and transports—all heavy users of hydrocarbons. On the contrary, we believe companies that have already begun investing in research and development for renewable, cleaner energy sources (such as wind and solar), are poised to make more green as these sources become more cost-competitive with fossil fuels. As ESG investors, we incorporate into our analysis a number of factors that would be indicative of a company’s ability to manage risks associated with energy, including:
- Greenhouse gas emissions intensity per sales
- Carbon per unit of production
- For oil and gas companies—embedded carbon in total reserves, production mix; and energy intensity per MBOE (thousands of barrels of oil equivalent) produced
Evolving outlook on defense
The changing outlook on the defense sector in the context of the invasion is a key example of how ESG investing may differ from exclusionary approaches (often called socially responsible investing, or SRI). Our principal goal as ESG investors is to improve risk-adjusted returns by ESG risks and opportunities into our analysis. Prior to the invasion, we viewed the aerospace and defense industry to be exposed to a significant amount of risk. The industry is heavily regulated and has historically faced a high degree of scrutiny due to products sold in complex areas, which can result in reputational and potential legal peril. As active managers, we adapt and adjust to the world as it changes and take new information under consideration when making investment decisions.
Contrary to our initial view, we are increasingly seeing opportunities within the defense sector as a result of this conflict. The Russian actions have been vehemently denounced, with 141 out of 193 United Nation (UN) member-states voting in favor of a resolution demanding Russia’s immediate withdrawal from Ukraine and the Ukrainian ambassador having accused Russia of genocide—a clear violation of the UN’s goals of peace and justice. In this context, ESG investors have begun to accept the investment opportunity set for the defense sector that can now provide value by enabling populations to defend themselves, protect their lands, and fight for their freedoms.
We are often asked is it possible to do well (financially) while doing good (socially). The crisis in Ukraine is an example of how moral and ethical issues can have a clear financial impact and how tail risks can wreak havoc on portfolios. We believe integrating ESG issues into the investment process can help improve long-term risk adjusted returns to client portfolios by focusing on resilient businesses that are built to be sustained. The Ukrainian crisis highlights some important elements of ESG investing. Whom you do business with matters and long-term stakeholder management is always more important that short-term investment profitability.