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Investors increasingly want fund managers to set investment ethical red lines. Extensive recent dialogue with our clients has shown investors are in favour of processes and engagement backed-up with the ultimate sanction of divestment. We endorse the positive allocation of capital to companies that are at the forefront of sustainable transition. However, this should not be at the expense of ensuring ethical and responsible behaviours.

Why divestment must be the ultimate ESG sanction

Neville White Neville White Head of RI Policy & Research
Opinion

Why divestment must be the ultimate ESG sanction

Neville White

Neville White
Head of RI Policy & Research

Investors increasingly want fund managers to set investment ethical red lines. Extensive recent dialogue with our clients has shown investors are in favour of processes and engagement backed-up with the ultimate sanction of divestment.

We endorse the positive allocation of capital to companies that are at the forefront of sustainable transition. However, this should not be at the expense of ensuring ethical and responsible behaviours.

Case for divestment

There is a growing voice among asset managers that argues by avoiding unethical companies, we leave ownership and therefore governance to investors uninhibited by ethical considerations. Yet fund managers make choices every day on stocks they hold and divest from on financial grounds.

It seems strange then that divestment on ESG grounds has become so contentious. Choosing not to allocate capital to companies exhibiting poor overall environmental, human rights and business ethics credentials is a perfectly valid risk-adjusted approach to ESG analysis and oversight. 

In what circumstances then would divestment support an ESG investment strategy? We apply the sanction to companies consistently failing to make progress in improving their performance in key areas such as climate change, or who have particularly poor records in fines, incidents, high health & safety accident rates or pollution. These factors reduce a company’s ability to achieve superior long-term performance, thus justifying divestment.

For example, we recently divested from Deutsche Bank, which was implicated in multiple financial scandals. Due to poor internal controls, the company saw ballooning contingent liabilities. However, our concerns centred around operational integrity, and culture became severely challenged by the ongoing failure to restore trust. Finally, a severe misconduct crisis, which included LIBOR rigging, mis-selling and money laundering – with serious implications for the long-term prospects of the company – prompted our decision to divest.

We believe the balance between good stock selection and constructive engagement, but with the ultimate sanction of divestment, provides a robust process of risk assessment for clients. It also provides the reassurance we have clearly established values with divestment red lines.

We also withdrew our investments in British multinational security services company G4S. The company was facing multiple ethical challenges over care and protection, including assault, use of non-approved restraint and more serious torture allegations in South Africa. Operating in a high-risk environment, there was mounting evidence G4S was failing to provide adequate care and custody. Our decision to divest was ultimately prompted by allegations of abuse at the Medway young offender unit.

A multi-layered approach

We certainly endorse engagement, but there is the perceived danger among industry observers that the responsible investment industry has turned engagement – and the pursuit of it for its own sake – into an excuse not to take more decisive action when needed.

The fossil fuel divestment campaign which emerged in 2010 has had a growing influence, backed by studies suggesting client portfolios may incur significant ‘stranded asset risk’, given the world needs to transition to a low-carbon economy, by keeping unexploited fossil fuel assets in the ground. This has built a powerful case on moral and financial grounds for avoiding or indeed divesting from fossil fuels in order to align portfolios more closely to the Paris Agreement target – keeping the increase in global temperatures to below 2C and limiting the increase to 1.5C.

We believe the balance between good stock selection and constructive engagement, but with the ultimate sanction of divestment, provides a robust process of risk assessment for clients. It also provides the reassurance we have clearly established values with divestment red lines.

We do not take the decision to divest lightly and always look to constructively engage with a company first. However, these efforts are not always rewarded. For example, Samsung Electronics has been mired in controversy regarding corruption and poor employee engagement for some time, and we had strong concerns over cobalt sourcing and the integrity of human rights within the supply chain. Governance remained a real problem, coupled with a culture of impunity given rising safety challenges. After engaging with Samsung following the arrest and conviction of senior management for corruption, the company’s lack of reassurance left us no choice but to divest.

At a time when financial services are suffering from high levels of mistrust, investment managers are under pressure to demonstrate active principles alongside wider ESG credentials. We believe divestment, deployed wisely, sits comfortably within a balanced strategy of focused engagement and research. Withdrawing client capital provides ultimate reassurance of the overall process, and one we know is supported by clients who seek strong values-led action from their managers.