Should investors sell out of companies they do not approve of, or try to force them to improve from the inside by remaining invested? 

That is the question many asset owners are grappling with, as they commit more explicitly to environmental, social and governance (ESG) standards. 

For many investors, the simplest approach is to avoid businesses whose activities they do not approve of. Under this approach, known as negative screening, asset owners refuse to let their money be invested into the equity or debt issued by the likes of coal miners, gun makers, casinos, or oil exploration companies.

While this strategy is easy to implement, it comes with downsides. For a start, some companies that may score poorly for ESG may be very profitable. Others may draw a minority of their revenues from distasteful sources. And then there is a moral quandary: if ethical investors refuse to use their money to pressurise such companies, how will their unsavoury practices ever improve? 

Instead, many fund managers promote a policy of engagement when making investments. This approach allows them to invest into companies with a poor track record on pollution or questionable governance standards, but only so long as the leaders of these organisations avow to improve their track record in these areas or at least demonstrate earnest efforts to do so.

This is a more complex approach, and it can be hard to draw a line: will fund managers really abandon investments into highly profitable companies whose executives say the right things but fail to make genuine efforts to, for example, decarbonise their operations?

Asset owners are increasingly feeling the pressure over their approaches too, as ESG-promoting organisations become more perspicacious about the investments the former are making. They are increasingly having to consider whether a policy of selling, naming and shaming may have more effect than pressure exerted behind the scenes. 

AsianInvestor asked a set of asset owners, ESG-promoting organisations and fund managers how to best respond to companies with poor sustainability track records.

The following responses have been edited for brevity and clarity. 

Rodrigo Madrazo, director-general
Cofides 

This is a key issue for us. We are in the process of assessing to what extent our investment portfolio is affected by carbon [exposure]. We have very few operations related to carbon sectors, so the key question is whether to implement an exclusion list or not. 

Of course, we intend to divest from those of our transactions that are affected by carbon over the coming few years. But the next decision we will need to make is: are we ready to implement an exclusion list?

In theory, such a list should be coherent, because if we are in the middle of a journey looking for impact investments, we would be walking in the opposite direction were we to accept brown transactions. We need to make a final decision there.

Derek Rozycki, head of responsible investing
Mubadala

We are in the process of considering our historical portfolio as we evolve. We feel strongly that the ability to transition assets with more challenging sustainability or ESG profiles is a very important component of effecting change.

It’s also necessary, because if we were to turn off the switch on all petroleum-based industries from today, it would be a very challenging environment for the global economy.

What we need to find is a way of transitioning. Just like climbing Mount Everest, we need to do it a step at a time.

There is no single destination to this journey. It is about installing a process that is ongoing, where we measure and make certain improvements week by week, month by month, year by year. And those improvements will have to happen in the assets we hold.

Fiona Reynolds, chief executive officer
The Principles for Responsible Investment

Divestment can send a powerful message to the market and certainty has a role to play, but it’s only part of the solution. Asset owners require a seat at the table if they are to influence a company’s business decisions, encourage them on a sustainable path and thereby effect long-term change. Another problem with divestment is that it opens the door for corporate shares to be picked up by less responsible investors. 

At the PRI, many of our signatories are choosing non-divestment options, including engagement, when it comes to issues such as climate change, for example. Investors, especially when they work collaboratively, are finding that flexing their financial muscle to engage with companies can yield better results. 

Engagement allows investors to query companies on their internal policies, whether it’s about transitioning their business away from fossil fuels to improving their diversity and inclusion programmes.

Another point often overlooked is the risk factors that face large institutional investors who are exposed in every market and sector. Divestment on a global scale simply isn’t an option without triggering serious volatility and asset price risks that will impact every fund and beneficiary. 

Sylvia Chen, senior sustainable officer
Amundi

Amundi considers divestment as a last resort or if justified by fundamental scientific reasons, like coal for instance. By divesting, the asset manager gives up any opportunity to exert influence over a business’ ESG practices and directions. On the contrary, staying invested in companies that demonstrate commitment to improve their ESG practices allows to promote the best sustainable practices within the sector.

This is why Amundi has put in place a strong engagement policy, articulated around three main axes: thematic engagement, ongoing engagement and engagement through voting. It is an essential part of Amundi’s fiduciary duty and its role as responsible investor.

Since 2019, we have been focusing our voting and engagement efforts on two priority themes: the energy transition and social cohesion. In 2021, we will continue to engage with companies on these themes as they are long-term goals that require continuous efforts for significant transformation to materialize.

We will strengthen our efforts to encourage corporates to adopt best practices in these areas, among other key sustainability topics.

Xiaoshu Wang, head of Asia Pacific team, 
MSCI ESG Research

This is a timely and urgent question, particularly in relation to climate.  MSCI has just publicly called upon asset owners globally to reallocate capital to less emission intensive investments and to green solutions aligned with accepted warming scenarios; to target a year-on-year decarbonisation of portfolios that allows for a reduction in the world’s total emissions by 10% a year; and to transition to a policy benchmark to help portfolios move towards net-zero.  

We believe ESG and climate factors will significantly impact the pricing of financial assets and the risk and return of investments, which will lead to a large-scale re-allocation of capital over the coming years. Investors who treat these factors as a fad and continue to operate in a wait-and-see mode could find themselves unprepared for the dramatic repricing of assets that could result.

Asset owners who have included ESG considerations in their long-term investment objectives should incorporate them into their policy benchmark to reinforce their commitment to sustainable investing and allow for objectives to be precisely defined and measured. The policy benchmark can then be compared against a market benchmark to compare the risk and return characteristics, quantify the impact of the strategic ESG decisions and monitor whether the expected ESG outcomes are achieved.

Hervé Guez, global head of research and CIO of equities and fixed income
Mirova

Some investors say that excluding companies based on ESG criteria means boycotting without giving them a chance to transition towards sustainability. Others say that a company with revenues (regardless of the amount) related to coal, oil, gas, tobacco, weapons or nuclear activities should be automatically excluded.     

This debate exists in part because of a confusion about the essence of a sustainable investment strategy and the role of institutional investors. Some may consider themselves to be universal asset owners who must engage with everyone to pave the way towards a responsible economy. And of course, if they manage huge amounts they can struggle to manage actively, for diversification and economic model reasons.

However, the concept of universal asset owners also ignores the primary purpose of a market: matching buyers and sellers to set prices. 

The best way to overcome this deadlock is for a responsible investor to combine a core allocation that features engagement initiatives, with an active impact allocation aiming to invest in sustainable companies. The question should then be: what’s the right proportion of active impact investing in an allocation? It’s up to each asset owner to find the most suitable answer. 

Paul Milon, head for stewardship for Asia Pacific
BNP Paribas Asset Management 

Divestment and engagement are two of the tools available for asset owners and asset managers, and they are both among the pillars of our sustainable investment approach at BNP Paribas Asset Management. Where there is scope for positive impact, we prefer engagement with issuers to exclusion.

As part of BNPP AM’s ESG integration guidelines, we may still invest in companies with a weak ESG score but aim to engage with these companies on key ESG issues. This is particularly relevant for Asia, where some companies may still lack formal policies and awareness, so a constructive engagement highlighting our areas of concerns can help drive improvements in companies’ ESG disclosure and practices. We adopted a similar approach with our coal policy. 

Take Asian electric utilities. Collectively they represent 23% of global greenhouse gas emissions, and most don’t meet our threshold for carbon intensity of power generation. We identified a handful of companies which are making credible commitments to reduce their coal dependency towards a level consistent with the objectives of the Paris Agreement. We placed them in our ‘under surveillance’ list, actively engaging with them to monitor the implementation of their decarbonisation plans. This engagement approach has helped facilitate tangible progress with some companies. 

Joe Marsh contributed to this article.

This article has been updated to include the opinion of MSCI.