To Exclude or Not to Exclude

Environmental, Social and Governance (ESG) investing will typically involve defining certain stocks or industries a strategy is not permitted to invest in. It is rare for an ESG product not to have any form of negative screening, and often difficult to be certified as an ESG product without a defined set of exclusions. However, the recent actions from Mike Cannon-Brooks’ private equity firm Grok Ventures, where an 11% stake in AGL was sufficient to halt the company demerging, highlights another approach that will be more effective in driving change (than a simple divestment approach).

AGL is one of the largest emitters of carbon listed on the Australian Stock Exchange (ASX) and as a result few, if any, ESG-based Australian shares funds will hold AGL in their portfolio. That said, ESG minded investors would want to see AGL decarbonise more quickly than would have happened, had the company’s plan to demerge not been challenged (and ultimately derailed) by the actions of Grok Ventures. This shows how shareholder activism and engagement with companies held in portfolios can result in positive change, rather than simply excluding such stocks from a permitted investment universe.

An important investor group, Climate Action 100+, uses the collective clout of 700+ investors from around the world, representing $68 trillion in assets under management, to engage with the world’s biggest emitters on reducing carbon emissions and their impact on the environment.

Russell Investments is a Climate Action 100+ signatory and we have been bolstering our active ownership resources as clients increasingly expect us to be ‘active owners’ of the companies we invest in. Last year, Russell Investments voted in favour of Engine No.1 directors, a U.S. based activist investor, seeking Exxon board membership – to help accelerate Exxon’s decarbonisation strategy.

In the case of the AGL demerger, it never made it to the shareholder vote, with the company abandoning demerger plans due to pressure from Grok Ventures. Exclusions certainly have their place, but the actions of Grok Ventures highlights the need for other approaches if investors expect their hard-earned dollars to have impact.

Russell Investments has a mix of strategies, and whilst AGL is not in the Russell Investments Australian Responsible Investment (RARI) ETF – due to a thermal coal and carbon reserves exclusion – we do hold AGL in other Australian shares strategies (which we would have voted on).

For ESG investors, it may make sense to use numerous strategies, rather than solely rely on exclusions to align funds with their ESG values. The Russell Investments Sustainable Managed Portfolios may be an attractive proposition in this case. The Australian shares exposure across the portfolios use a standard set of exclusions that are expected in the Australian retail market: alcohol; gambling; and fossil fuels. However, the global shares exposure use a ‘darker green’ allocation to a more impact-based equity strategy, combined with an allocation to Russell Investments Low Carbon Global Shares Fund. The Russell Investments Low Carbon Global Shares Fund follows our proprietary decarbonisation strategy and, whilst exclusions play a part, the fund invests in oil and gas companies and leverages our active ownership activities – such as the Exxon vote mentioned above.

The bottom line

ESG investing is rightly under the spotlight given how popular it has become. But it is often not black and white whether or not to include a stock in an ESG strategy.

The recent controversy over Exxon replacing Tesla in the S&P 500 ESG index highlights the inefficiencies of some index-based ESG strategies given there can be no qualitative overlay in a rules based methodology. Often a pragmatic approach with multiple lenses and a diversified set of strategies is the most effective way of investing broadly in ESG. Exclusions have their place but will not result in change the way active ownership can.