Geopolitical risk is hard to measure in ESG, and it’s not going away

Russia’s invasion of Ukraine caught some ESG investors off guard, but geopolitical risks may be difficult to avoid with certain strategies.

Lucas White, portfolio manager for resources and climate change with Boston-based GMO, said his climate strategy invests in companies producing materials needed to transition away from fossil fuels, such as nickel and copper.

“You can’t just decide where you want to get nickel,” White said Tuesday at the Morningstar Investment Conference in Chicago. He was speaking on a panel about investing in the climate transition.

Russia is a major producer of nickel and copper, which is used in everything from wind and solar energy to electric vehicles and charging stations.

“They have a brilliant commodity mix from a clean energy perspective,” White said.

“Copper is kind of like the oil of a clean energy economy.”

Stephen Liberatore, lead portfolio manager for ESG fixed-income strategies with Chicago-based Nuveen, said the Ukraine war was a good reminder that managers must do their own research rather than rely on rating agencies. While he never owned Russian debt, he said, until February it was in his fund’s eligible universe.

“I’m not sure how an authoritarian regime entirely tied to the fossil fuel extraction industry with no concept of transition would ever be considered an ESG leader,” he said at the Morningstar conference.

While rating agency reports are useful and their analysts often spend more time with issuers than portfolio managers can, Liberatore said, ultimately, managers need to use their own expertise and consider what their investors are looking for when constructing portfolios.

The Russian sanctions and capital flight offer a warning about the ESG approach to China, an even larger market for clean energy technology. Since Russia’s invasion of Ukraine, investors have worried about the consequences of a Chinese invasion of Taiwan.

White said Chinese companies are integrated in the value chains of many clean technologies. Western sanctions on a scale similar to those imposed on Russia would have “huge implications” for clean energy markets, he said.

“That’s a big risk for my strategies, and one that I can’t really hedge in any obvious way because I don’t have much direct exposure to China,” he said.

The panel on Tuesday covered a range of ESG issues, from market valuations to the subjective nature of green investing.

While the panellists agreed they would avoid investing in coal companies in any way, there was less agreement about how nuclear power fits into portfolios.

Liberatore said that’s one of the interesting parts of investing from an ESG or impact perspective. “It is inherently subjective,” he said. “What you may think is green is different than what I think is green.”

As for the market environment for green investing, the panellists said there is a lot of capital chasing certain opportunities.

Lisa Beauvilain, head of sustainability and ESG with London, U.K.–based Impax Asset Management, said she’s seen “various instances of over-excitement” in the last 20 years. For that reason, managers need to be “incredibly disciplined around valuation,” she said.

“It’s a growth market, there’s a lot of innovation, and you inevitably will get moments where investors get too excited, too positive, too optimistic,” she said.

At the moment, there’s too much capital chasing solar and wind project returns, White said, which is limiting returns. Investors have to look at individual opportunities before reaching conclusions.

But while opportunities may be specific, Beauvilain warned that the physical risks from climate change are broad and, in some cases, still poorly understood. Climate modelling can help investors assess risks from storms, rising sea levels and other effects, but geolocation data is lacking for many companies, preventing investors from getting a full picture.

“I think it’s been viewed, traditionally, as a company secret,” she said. This makes sense for oil assets, for example, but for most companies it’s “a more neutral question.”

Beauvilain is advocating for broader company reporting on the location and management of physical assets.