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Why ESG funds 'shockingly' buy Russian oil instead of Canadian crude

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·4 min read
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Many of the world’s largest companies and institutional investors have severed ties to Russia in recent weeks amid increasingly violent attacks on Ukraine. (REUTERS/Alexey Malgavko)
Many of the world’s largest companies and institutional investors have severed ties to Russia in recent weeks amid increasingly violent attacks on Ukraine. (REUTERS/Alexey Malgavko)

Russia's war on Ukraine continues to expose uncomfortable realities for environmental, social and governance-focused (ESG) investments, prompting calls for the asset management industry to rethink the loosely-defined term as analysts point to "shocking" holdings within some funds.

A new report from CIBC Capital Markets shows many of the 10 largest energy holdings across ESG funds have pared down or exited investments in Canada's oil sands, while half stayed invested in Russia. At the end of 2021, the bank found ESG funds owned twice as much Russian oil and gas as Canadian oil and gas.

"Perhaps most shockingly, the ratio of dollars held in Gazprom (a Russian state-owned energy firm) was six times that of Suncor," the CIBC analysts wrote in research published on Monday.

According to the report, the big four Russian energy companies, NK Lukoil, Novatek, Gazprom and NK Rosneft, accounted for about 0.2 per cent of the global ESG holdings. That's double the size of investments in Canada's TC Energy (TRP.TO)(TRP), Suncor Energy (SU.TO)(SU) and Canadian Natural Resources (CNQ.TO)(CNQ), the bank said.

"Russia and Saudi Arabia may well emit less CO2 per produced barrel of oil equivalent than some North American firms, but they also invariably have less robust social and governance oversight," the CIBC analysts wrote.

"This says nothing of the reality many of their energy entities are de-facto state controlled and often aligned (read: weaponized) with foreign policy objectives – many of which will be an affront to mainstream ESG investors."

Several of the world's largest companies and institutional investors have moved to cut ties to Russia in recent weeks, amid increasingly violent attacks on Ukraine's population. ESG funds held at least US$8.3 billion in Russian assets before Russia invaded Ukraine, according to data compiled by Bloomberg.

Those include the country's financial firms. Bloomberg News recently reported that Vanguard Group and Northern Trust upped their stakes in Russia's leading bank through their respective index-based ESG funds in January, as Vladimir Putin's forces amassed on Ukraine's borders.

Vlad Tasevski, chief operating officer and head of product at Purpose Investments, says these examples show the need to rebalance the trio of ESG priorities. He says the environmental "E" in ESG is being over-emphasized, likely due to the greater challenge of measuring the social and governance variables, compared to hard carbon emissions data.

"I think we are going to see a reassessment both by investors, and the data providers of information for ESG factors," he said in a phone interview. "Work on the 'S' and 'G' has been around for a while, but it's still newer. They're maybe not as straightforward as the environmental factors."

Tasevski isn't overly surprised by the lack of enthusiasm for Canadian fossil fuel producers across ESG funds. He says Canadian producers have been "overwhelmingly negatively impacted by the ESG movement," even as the industry has worked to shrink its carbon footprint, and invested in technology like carbon capture and storage.

CIBC says global flows into ESG funds were down more than 50 per cent through the first two months of this year, after setting records in 2020 and 2021. The bank says flows out of ESG funds have outpaced net outflows from other asset classes.

"Perhaps the recent uptick in ESG fund outflows is simply a reflection of investors becoming aware that simple 'black box' metrics, such as ESG scores, often used in security selection, are inadequate for a topic as multifaceted as ESG," the analysts wrote.

Is ESG good for investors?

Danielle Fugere, president of the California-based shareholder advocacy group As You Sow, says ESG is an umbrella term that's never been clearly defined. She notes many ESG funds in the United States can be labelled "carbon free," even if they hold fossil fuel assets, under Securities and Exchange Commission (SEC) rules.

On Monday, the SEC released a proposal for what could become its first-ever mandate for what U.S. companies need to tell investors about their carbon footprint. Fugere says investors are better-served when corporate climate analysis is separated from unrelated social and governance measures.

"Climate is its own area," Fugere said in an interview. "It should be appropriately removed from issues of human rights."

Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.

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