The case for investing in non-ESG stocks 

As one might expect, the Church of Eng­land is a fas­tid­i­ous investor. To reflect its high­er pur­pose, it needs an appro­pri­ate­ly celes­tial strat­e­gy for the £9bn under its man­age­ment. 

The Church declares: “We exclude from our direct invest­ments com­pa­nies involved in indis­crim­i­nate weapon­ry, con­ven­tion­al weapon­ry, pornog­ra­phy, tobac­co, gam­bling, non-mil­i­tary firearms, high-inter­est-rate lend­ing, human embry­on­ic cloning, the extrac­tion of ther­mal coal…” 

The list goes on. It’s also a no to busi­ness­es involved in “egre­gious con­tro­ver­sies”, firms that have a dam­ag­ing social impact and even those con­sid­ered poor at report­ing. All investees must meet its strict envi­ron­men­tal, social and gov­er­nance (ESG) cri­te­ria. 

The C of E’s eth­i­cal approach may be admirable and whol­ly fit­ting for an organ­i­sa­tion of its nature, yet (squea­mish read­ers may wish to turn the page now) it could be fool­hardy from a finan­cial stand­point. As more invest­ment man­agers set high ESG bars, the stocks they shun for falling short begin to become bar­gains for those still pre­pared to touch them. For investors open to cig­a­rettes, alco­hol and guid­ed mis­siles, there may be easy mon­ey to be made. 

The events of Q1 might prompt even the most pious of investors to rethink. Russia’s inva­sion of Ukraine at the end of Feb­ru­ary trig­gered a shift in glob­al mar­kets. Defence stocks soared, for instance. The share price of BAE Sys­tems, mak­er of the Stormer armoured vehi­cles that the UK has sent to Ukraine, shot up on the day that Russ­ian troops crossed the bor­der. So did those of Ital­ian defence con­glom­er­ate Leonar­do and French giant Thales Group, mak­er of the Starstreak mis­sile sys­tem that Ukraine is using to defend its air­space. 

And the wide­spread relax­ation of Covid restric­tions has released pent-up demand for booze and fags, as con­sumers flock back to pubs and bars. The share price of drinks giant Dia­geo slumped in the ear­ly months of the pan­dem­ic, but it has since roared back to record highs, while cig­a­rette mak­er Philip Mor­ris Inter­na­tion­al is hav­ing a sol­id year.

So is there mer­it to an anti-ESG strat­e­gy – to reap where oth­ers won’t sow? As major asset man­agers such as Black­Rock and Norway’s £1.1tn sov­er­eign wealth fund avoid non-com­pli­ant stocks, log­ic sug­gests that stakes in prof­itable com­pa­nies may be avail­able at a knock-down price. 

There’s also the ques­tion of whether arch­bish­ops and oth­er right­eous investors are cor­rect to exclude cer­tain stocks. After all, the defence of Ukraine has been hailed across the demo­c­ra­t­ic world as a noble cause. 

Ger­man defence com­pa­ny Rhein­metall is the mak­er of Leop­ard tanks and Marder armoured vehi­cles, both of which are bad­ly need­ed by Ukrain­ian forces. In March, its CEO, Armin Pap­perg­er, told the FT: “Some months ago, peo­ple want­ed to ban us; to say that this indus­try is a very bad indus­try… It’s a total­ly dif­fer­ent world now.” 

When it comes down to pure returns, it’s hard to find con­vinc­ing evi­dence that sup­ports saints or sin­ners. The MSCI World ESG Lead­ers Index, which tracks the per­for­mance of eth­i­cal­ly com­pli­ant large and medi­um-sized com­pa­nies, nar­row­ly beat the tra­di­tion­al MSCI World Index last year. The two indices have matched each oth­er close­ly over the past five years. 

Yet recent research by finan­cial ser­vices firm Refini­tiv Lip­per indi­cates that ESG per­for­mance has been dip­ping. Although the ESG com­pa­nies it mon­i­tors out­per­formed over three- and five-year peri­ods in the top-sell­ing sec­tors, their returns have trailed about 8% behind those of their non-ESG equiv­a­lents over the past 12 months. 

Price lurch­es dur­ing wars and pan­demics may offer false insights. Joe Smith, invest­ment ana­lyst at Equi­lib­ri­um Invest­ment Man­age­ment, argues that you’d be fool­ish to base your allo­ca­tion choic­es on volatile world events. 

“If you had looked two years ago at the case for the prices of oil and gas ris­ing as they have done, you’d have need­ed to fore­see a ter­ri­ble con­flict to deliv­er such returns,” he says. “It would have been a very spec­u­la­tive thing for you to have sat there and said: ‘I think there will be this con­flict that will dri­ve up prices.’”

In Smith’s view, it’s bet­ter to focus less on black-swan events, no mat­ter how seis­mic, and take a longer-term view. The the­o­ry is that ESG stocks should pre­vail even­tu­al­ly. 

“Con­sid­er tobac­co, for instance,” he says. “Sales are declin­ing in the younger pop­u­la­tions. And in old­er pop­u­la­tions it is known to be harm­ful. It’s a prod­uct that kills its cus­tomers. There will come a point when the cus­tomer base won’t be there any­more.”

But the reli­a­bil­i­ty of some process­es by which firms are classed as ESG stocks has been called into ques­tion. Researchers at Colum­bia Uni­ver­si­ty and Lon­don School of Eco­nom­ics com­pared the records of US com­pa­nies in 147 ESG fund port­fo­lios with those of firms in 2,428 non-ESG port­fo­lios. They dis­cov­ered that the for­mer group gen­er­al­ly had worse com­pli­ance records with reg­u­la­tions pro­tect­ing both labour rights and the envi­ron­ment.

Rat­ings agen­cies do reflect this uncer­tain­ty. Impe­r­i­al Brands, mak­er of Gaulois­es cig­a­rettes and Mon­te­cristo cig­ars, for instance, receives an A rat­ing from MSCI for its work in help­ing farm­ers to diver­si­fy their income and con­struct­ing solar-pow­ered water pumps in Malawi. And brew­ing giant AB InBev has won praise from ESG fund man­agers for set­ting a tar­get for 20% of its income to be gen­er­at­ed by low-alco­hol and alco­hol-free beer by 2025. 

“I don’t think things are as black or white as we’ve been led to believe,” says Dr Andrew White, senior fel­low at the Uni­ver­si­ty of Oxford’s Saïd Busi­ness School. “Not all oil com­pa­nies are the same, for instance. At BP, they are seri­ous about their tran­si­tion away from fos­sil fuels. Even invest­ing in arms can look quite dif­fer­ent today.”

St Thomas Aquinas, the medi­ae­val priest and philoso­pher, argued that war could be jus­ti­fied if it met cer­tain con­di­tions, writ­ing: “It is nec­es­sary some­times for a man to act oth­er­wise for the com­mon good, or for the good of those with whom he is fight­ing.” 

In light of recent events, per­haps even the arch-paci­fists at the Church of Eng­land might want to rethink their ESG black­list.