With the world already undergoing critical changes off the back of the COVID-19 pandemic, Russia’s invasion of Ukraine and the subsequent war in the country have set off a chain of events as many countries jostle for position in a power play dynamic. MAHIR JAKOET weighs in on how geopolitical uncertainties impact investment decisions.
As a result of these events, the global environment is currently one of accelerated inflation, where rising prices are straining the budgets of consumers. Monetary policies are being triggered to counter inflation, resulting in a greater debt burden for countries, while continued lockdowns, particularly in China, have created bottlenecks regarding supply chains. On top of this, geopolitical turbulence has led to countries focusing inward, resulting in a protectionist stance, which slows trade, decreases cross-border opportunities and keeps out foreign investment.
Within this context, investment professionals find themselves at a consequential moment, trying to navigate through a volatile global environment against the backdrop of the heartbreaking human suffering of the Russian–Ukrainian war, which will have significant and far-reaching consequences.
War and investment opportunity
The term coined in 1800, “Buy on the cannons, sell on the trumpets”, attributed to London financier Nathan Rothschild, suggests that the start of a war is a good time to invest in the stock market, while the end is a good time to sell. Historical data shows that the start of most wars would be an opportune time to get into the stock market, bar one, the Yom-Kippur war, which occurred during a period of accelerated inflation and was also followed by high oil prices. This environment rings a bell, and while the Russia–Ukraine war may prove to be different, it is having an ongoing impact on energy, global security and food security, with dramatic effects throughout the global economy.
Buying on the cannon certainly has credibility, but the investment opportunity from the Shariah and ESG vantage points is the challenge that we currently battle with. This is where we find investment and ethical stances at a crossroads.
While there is a strong intersection of Shariah and ESG investing, there are important differences. The broad definition of ESG investment is to observe, during investment decision-making, how ESG risks and opportunities can cause material impacts on a company’s performance. Shariah investment, on the other hand, is based on Shariah financial principles of Islamic finance, which have remained unchanged historically since their development over 1,400 years ago. The universe excludes weapons, alcohol, tobacco, gambling, conventional financial services and pork — which are not considered problematic in general ESG strategies; however, it does not exclude fossil fuels. Ethical investing requires hard investment decisions, but we firmly believe that ethics, in line with ESG, needs to be incorporated into all investment processes as it is the right thing to do.
How has the war inflated the problem?
ESG investing increasingly sees environmental concerns intersecting with social issues. For example, two of this year’s best-performing groups in global markets are energy (E risk) and defense (S risk), presenting challenges to the performance of an ESG-inclusive framework, which are exacerbated by increasing defense budgets and sanctions on Russian oil. Therefore, including ESG in an investment framework that underweighs/excludes fossil fuels and weapons may create more pain in 2022.
Geopolitical events present not just a performance conundrum for ESG-focused or ethical institutional investors, but a philosophical one as well, as the narrative around defense appears to be shifting from ‘manufacturers of harmful weaponry’ to ‘preservation of human rights’. The current conflict has governments committed to spending more than 2% of GDP on defense and the Bank of America estimates that US defense spending could rise to at least 3.5%, reaching as much as 4% of GDP (from 2.8% currently).
Stick to your process and do the right thing
While the current war may have a more severe impact on many markets, many stock markets have already recovered to pre-invasion levels. Markets have been conditioned to react to geopolitical shocks and our investment process emphasizes quality companies anchored by robust balance sheets and high cash flow generation.
Our disciplined investment framework incorporates ESG in an already highly ethical universe (Shariah and ESG funds). We use a rigorous risk analysis process and partner with an in-house responsible investment (RI) team, which gives us incredible insights and a competitive advantage for our pursuit of investment excellence.
Our RI team provides granular ESG expertise and strong relationships with investee companies, coupled with active stewardship. This helps to see around corners and prepares the investment team and the broader business for possible dilemmas or challenges that may lie ahead. With their guidance, we regularly engage with companies to seek investments that provide our funds with an ESG profile premium and lower carbon footprint.
While the ESG process can be subjective, there is growing pressure for listed companies to adopt ESG approaches, which we believe will have structural tailwinds for these businesses in the hope of better performance over the long term.
Maahir Jakoet is a portfolio manager at Old Mutual Investment Group.