Ethical funds are hypocrites to take money from authoritarian regimes

Investment firms are using their financial clout to aid despots while claiming the moral high ground

‘While firms have become ultra-picky about how they invest their clients’ money they are far less circumspect about who those clients are’

Having dodged a bullet and avoided much of the blame for the financial crisis, the global fund management industry could now be heading for a belated and mighty comeuppance.

Ironically, its undoing will likely be the fundamental contradictions at the heart of ethical investment, which has been both a brilliant market ploy and a misplaced attempt at redemption after failing to ask the right questions when banks were selling toxic dross.

Arguing that profit-seeking companies can and should help save the planet was an easier sell when the practice of environmental, social and governance (ESG) investing made money. Now it’s not.

Much of the past outperformance of ESG funds appears to have actually been the result of filters skewing investment towards growth stocks like the big technology companies. When the air started to come out of that bubble at the beginning of last year, the performance of many ESG funds started to look similarly deflated.

At around the same time, Vladimir Putin’s troops started marching into Ukraine, driving several tank squadrons through the investment industry’s moral certainties. Ethical funds have, for example, long shunned defence stocks. But, suddenly, supplying weapons to a country defending itself against an illegal invasion was the biggest moral imperative of the day.

Likewise, the wisdom of divesting from fossil fuel companies, and thus increasing their cost of capital, looks increasingly untenable. You can easily make the argument that it resulted in reduced exploration and production, which has in turn contributed to the sharp rise in fuel prices and higher inflation.

Ethical considerations are, almost by definition, subjective. Last year, as Russian troops were massing on the Ukrainian border, the Latvian deputy prime minister publicly hit the roof when a Swedish bank refused to issue a loan to one of his country’s defence companies because of “ethical standards”.

“I got so angry,” said Artis Pabriks in an interview with the Financial Times. “Is national defence not ethical? How is the Swedish defence industry financed – by Martians?” Well put.

Meanwhile, fund managers have ridden their high horses slap bang into the middle of America’s culture wars. Republican attorneys-general in several states have accused Blackrock, the world’s largest investment firm, of misusing its market power by boycotting oil companies. At the same time, watchdogs in New York, which is a Democratic state, are arguing that Blackrock isn’t green enough. The firm rejects both charges, but is nevertheless clearly in an unenviable spot.

Amid this growing furore is another startling hypocrisy that is rarely remarked upon.

While fund firms have become ultrapicky about how they invest their clients’ money they nevertheless are far less circumspect about who those clients are.

Many large fund managers look after money for authoritarian states such as China and Saudi Arabia that are facing accusations of serious human rights violations. Toby Nangle, who quit the industry last year over his concerns about exactly this issue, describes it as the fund management industry’s “trillion-dollar blindspot”.

By some estimates, authoritarian regimes have about $10trillion (£8.3trillion) of assets in sovereign wealth funds, central bank reserves and public pension schemes. Not all of this is managed by Western investment firms, but a good chunk is.

As Nangle says, those firms who manage these funds have “effectively become outsourced treasury officials ... [helping] authoritarian states around the world to finance aims that can be both repressive and repugnant”.

It is possible to make the argument that finance is essentially amoral, is fundamentally ill-equipped to tackle ethical issues and should focus on what it does best: seeking to generate long-term value. It is equally possible to argue that investment firms should be using their collective financial clout to help solve the world’s most intractable problems.

I personally lean towards the first position. Our whole capitalist system has been built from the ground up in order to maximise shareholder wealth. That sounds a little icky, but the reality is that things get very messy very quickly when you start adding in different and, at times, competing aims.

There is also a fairly forceful argument that ethical investment could actually be counterproductive. By, for example, persuading people that you can deal with climate change through green investment, which is doubtful for any number of reasons, you may reduce the impetus behind initiatives that have a better chance of genuinely addressing the problem, such as an international carbon tax.

But, regardless of which side you come down on in this debate, it is extremely hard to justify taking an amoral approach in deciding who you sell your services to at the same time as feigning squeamishness about how that money is invested.

In what moral universe is it OK, for example, to accept money off the world’s largest petro-state, which routinely jails peaceful dissenters and has killed thousands of civilians in Yemen, but not OK to invest in the shares of Western oil and gas companies that will be producing the energy we need for decades to come?

Since he quit his job last year, Nangle has been busy drawing up a set of principles that will better guide the investment industry on which clients to work for. He is admirably clear-eyed about what this will achieve: not much.

As he wrote in a recent opinion piece for the Financial Times: “Fund managers downing tools won’t stop torture, extrajudicial deaths or other awful things that some clients are responsible for. At most ... it might make odious regimes marginally poorer.”

That said, he argues it’s worth doing because, for one, it’s the right thing to do and, for another, a growing number of staff in the fund management industry have similar reservations about managing lucre for despots.

What he doesn’t say, but is nevertheless also true, is that such an approach will help the fund management industry mitigate the accusation it is currently engaged in breathtaking hypocrisy.