Investments | 26 April 2022
The G in ESG: Why governance is crucial in shaping our response to the invasion of Ukraine
Good governance is a key tenet of responsible investing and helps the companies we invest in mitigate risk and thrive in the long term.
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Russia's ongoing invasion of Ukraine has presented a significant test for responsible investors like Coutts. As a purpose-led business and certified B Corp, we invest your money to make a positive difference to the world without compromising potential long-term returns. As such, we must evaluate both our direct and indirect holdings to make sure they are in line with those investment principles.
In response to the tragic situation unfolding in Ukraine, Coutts is exiting Russian assets. Exposure to Russian assets in a typical balanced portfolio was around 0.1% of portfolio value, but we’re looking to bring that down to zero. Our criteria for responsible investing, allied to our wider macroeconomic investment view, has been crucial to why our exposure was so low.
A central tenet of that criteria is the ‘G’ in ESG – corporate governance. Turbulent events such as wars and terrorist attacks pose tricky questions of investors, but by investing in companies with strong governance principles we can mitigate some of the risk.
A question of governance and risk
While the environment and social sides of ESG are easily understood, governance can feel a little more nebulous. It comprises multiple aspects of corporate behaviour, including business ethics, corruption and instability, anti-competitive practices, and ownership.
According to research by MSCI in February 2021, companies with strong corporate governance had significantly better profitability, lower stock-specific risk, and lower systemic risk. Meanwhile, those with less boardroom diversification and less transparent, scrutinised practices, or those that don’t respect or promote workers’ rights, all perform poorly in comparison.
“At Coutts, being purpose-led helps us identify risk,” stated Karen Ermel, Director, Responsible Investing at Coutts. This starts by looking closely at a company's governance measures and ensuring adequate regulatory oversight to filter out funds that do not meet set standards or are below industry averages for particular ESG factors. Considering everything from inflation and interest rates to diversification helps assess a company or fund's suitability for responsible investors, Karen added.
Indeed, in prioritising governance, Coutts has reduced their exposure to Russia, says Leslie Gent, Head of Responsible Investing at Coutts. “We stay on top of the issues, have a good understanding of the risks in our portfolios, and try to size those risks appropriately.”
What action can, and do, we take?
We vote at shareholder meetings to push for positive change in companies. For those in Coutts-owned funds, we work with our voting and engagement partner EOS at Federated Hermes (EOS).
In its response to Russia's invasion of Ukraine, EOS has temporarily paused engagement with Russian companies (defined as companies listed in or with most of their assets and operations in Russia). EOS argues that they don’t believe that businesses in Russia will engage with them meaningfully.
At the same time, EOS is asking all non-Russian companies in their engagement programme who have material connections to Russian clients, suppliers, or counterparts to update them on the potential impact of the invasion and sanctions. This covers their business and how they are being managed; employees in the affected region; and what due diligence they are undertaking to identify human rights issues.
Keeping a long-term perspective
Many investors are understandably concerned about the current market volatility and its impact on their funds. But investing requires you to keep a long-term perspective, and not get spooked in the short term – ‘time in the market’ is better than ‘timing the market’.
Companies with good governance have been shown to be more successful over the long term, better able to manage risk and ride out turbulent times. By using ESG principles to assess who we invest in, we aim to back companies that are good for the future and your future returns.