Does ESG Investing Allow a Country to Defend Itself?

A friend was mentioning the other day this great little app she has on her phone that helps her make sure the mutual funds she is investing in don’t own stock in companies that make guns.  Apparently, you put in the names of the mutual funds and it tells you whether they own stock in companies making guns. 

This is part of the ESG investing trend.  “ESG” stands for “Environmental, Social, Governance.”  The idea is to have a set of criteria that socially conscious investors can use to screen their investments.  “Environmental” criteria cover how a company performs with respect to environmental and sustainability standards.  “Social” criteria grade how a company manages its relationships with employees, suppliers, customers, and the communities where it operates, i.e., its stakeholders.  “Governance” looks at things like a company’s leadership, executive pay, audits, internal controls, and shareholder rights.

Some people think that evaluating companies on an ESG basis will get them a better return because it will exclude companies with greater financial risks due to their environmental practices, etc.  Other people don’t care if they earn a little less; they just don’t want to invest in certain types of companies.¹ 

I understand this.  The problem for me comes in when people start expanding the ESG criteria.  It’s one thing to exclude gun makers.  But some people expand that to exclude companies making nuclear weapons because they, too, are bad.  Or even what are called “controversial weapons.”  Others go beyond this to include any weapons at all.  Last year, for example, the Bavarian state-owned Bayerische Landesbank began “fading out business relationships with companies … [having] above 20 per cent turnover in defence.”²  In the United States, the Vanguard ESG Global Corporate Bond ETF follows an index, developed by MSCI (i.e., Morgan Stanley Capital International), that excludes bonds of companies who get revenue above a certain level from, inter alia, “nuclear weapons, controversial weapons, and conventional weapons.”  

Aris Pabrika, defense minister of Latvia, complained about a Swedish bank (Swedish banks dominate the Latvian financial sector) refusing a loan to a Latvian defense company, apparently because lending to a defense company would violate its “ethical standards.”  Richard Milne of the Financial Times noted that this “follows a pattern of banks and investors, not just in Sweden but across Europe, refusing to back defence groups as it goes against their environmental, social and governance policies.”³

Defense minister Pabrika was livid: “How can we develop our country?  Is national defence not ethical?”  As Mr. Milne asks, with Russia having 100,000 troops on Ukraine’s border, “how can banks and investors fail to support companies helping protect their countries?”³ 

Thus far, this anti-defense idea seems more advanced in Europe than the United States, but it is growing here, too.  The question is: If defense companies or weapons manufacturers can’t get loans, or find it harder to get loans, or if people won’t invest in them, how do they do their job?  How do they make the weapons that our defense forces need to defend us?

Perhaps Peggy Hollinger said it best in column she wrote in the Financial Times last December: “Of course weapons are harmful.  But they are even more harmful if those who threaten you have them and you do not.”⁴
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¹ It’s also a way, in some cases, for grifters to make money advising people how to invest for ESG.  (That’s the cynic in me.)
² Peggy Hollinger, “EU must think twice before branding defence industry harmful,” Financial Times, December 2, 2021.
³ Richard Milne, “Swedish ESG investors’ disdain for defence leaves Latvia uneasy,” Financial Times, February 3, 2022.
⁴ Peggy Hollinger, “EU must think twice before branding defence industry harmful,” Financial Times, December 2, 2021.