Investing in companies based on environmental, social, and governance (ESG) factors is one of the hottest trends in the fund management industry, attracting more than $35 trillion in investments by the beginning of 2020.
However, for money managers from Boston to London, the focus has been mainly on companies, with governance risk ignored, especially in decisions about whether to invest in a country itself.
China has denied allegations of human rights violations against Uyghurs in southern Xinjiang. The Saudi government has stated that a rogue group carried out Khashoggi’s assassination.
The analysis focuses on the risk of an investment, rather than a country’s human rights record or other governance factors; for approximately 71% of the $35 trillion invested with an ESG focus.
It may be easier to disregard human rights if an ESG fund manager believes that the chances of losing money on an asset, such as a sovereign bond, are sufficiently low given its price; for example, the security of the relevant country’s ruling government.
According to Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics, Western investors are more concerned with shareholder value than with human rights when making investment decisions in China.
It is especially true “Climate, biodiversity, human rights violations, and poor state governance are examples of systemic ESG risks.
Government crackdowns can sometimes result in more investment flowing into the country as disruptions to daily economic activity cease; seen after China stopped pro-democracy protests in Hong Kong two years ago.
In 2021, foreign direct investment into China increased by 14.9%.
Beijing rarely discusses democracy but has previously referred to China’s governance arrangements as “democratic.” “People’s democracy as a whole
Reward for risk
International investors, for example, were chastised last year; they held bonds issued by Belarus during the country’s President Alexander Lukashenko’s crackdown on protesters.
As a result of Beijing’s regulatory crackdown last year, investors in a wide range of Chinese companies suffered losses; these ranged from technology to real estate developers.
Some funds have withdrawn their investments in such countries; they cite reputational and moral concerns and the risk of loss. These have tended to be smaller funds.
Most have stayed, not least because exiting becomes more difficult as the market grows more prominent.
According to Refinitiv data, the BlackRock (NYSE: BLK) iShares ESG Aware MSCI EM ETF fund has around 3% invested in Russia; however, 28% in China.
People criticize me for investing in China rather than Russia, but it’s very nuanced; the critics are typing on a Chinese-made iPhone and wearing Chinese-made clothing.
Norway’s $1.3 trillion sovereign wealth fund announced the exclusion of China’s Li Ning; the reason behind this was an “unacceptable risk” that the sportswear manufacturer was contributing to serious human rights violations in Xinjiang, China.
Risk to Sovereignty
According to Diliana Deltcheva, head of Emerging Market Debt at asset manager Candriam’s SRI Bond EM Fund, one major factor missing from ESG calculations is market pricing of sovereign debt; it has long excluded Russian, Belarussian, Chinese, and debt from Gulf states.
In the case of Russia, foreigners hold nearly $80 billion in debt, including sovereign bonds denominated in roubles, euros, and dollars, as well as hard currency corporate securities, with investors outside Russia owning 86 percent of Russia’s stock market free float at the end of 2021.
Furthermore, Western corporations, ranging from BP (NYSE: BP) and Societe Generale (OTC: SCGLY) to Citigroup (NYSE: C) and Apple (NASDAQ: AAPL), strengthened their ties with Russia.
