With the Russo-Ukrainian war and its impact on European energy markets and global agricultural supply chains, the international outcry surrounding Israeli military actions in the Palestinian territories and Lebanon, and most recently the impact on oil prices linked to the American military campaign in Iran, geopolitical conflict is becoming an increasingly significant risk for fund and investment managers.
Introduction
The cost of war can be measured in many ways, and it should never be forgotten that loss of life, injury, displacement, and other direct impacts on human lives are the greatest costs of all. That said, wars and conflicts also impact on economies and livelihoods in regions far removed from the front lines, and it is the responsibility of investment professionals to limit the risks associated with these impacts.
Risks to Assets, Profitability, and Cashflow
One of the most immediate risks of conflict exposure to the profitability and cashflow of businesses is that of damage to assets. If a company operates in regions where the potential for conflict is greater, there is naturally a greater risk that any physical assets in these regions could be at risk of damage from such things as bombings, airstrikes, or fires.
This does not, however, mean that companies should arbitrarily avoid any operations in such areas, or that fund managers should avoid investing in companies that have operations and/or assets located in them. Instead, companies should implement adequate risk mitigation and insurance measures, and fund managers should either endeavour to ensure that any potential investee companies have sufficient measures in place, or engage with them on the topic.
Closely related to risk of damaged or destroyed physical assets is the risk of assets being rendered inaccessible. Conflicts can prevent businesses and their employees from being able to access and operate assets such as factories and facilities, as well as effectively trapping products and resources in a particular region. This was perfectly demonstrated by the American military operation in Iran and the resulting ‘closure’ of the Strait of Hormuz, which saw significant quantities of ships (and the resources with which they were loaded) being unable to sail between the Persian Gulf and the Gulf of Oman.
The closure of the Strait of Hormuz also demonstrates how conflict-related risk is exacerbated by the interconnectedness of global supply chains. Businesses and economies in Asia, for example, are heavily dependent on oil and gas that is shipped through the Strait, and so while an American-led conflict on Iran might appear to pose little direct risk to a manufacturer in China, globalisation and complex supply chains means this is simply not the case.
Reputational Risks
Beyond operational and supply-chain risks, exposure to conflicts can present reputational risks to companies. This is especially the case where they are linked to a state or actor deemed to be an unjustified aggressor, or that is found to be facilitating abuses of human rights. These links can negatively impact on corporate image and brand perception among various groups, which can affect businesses in various ways.
Consumers are one such groups that are likely to come to mind, as boycott campaigns are often one of the most public displays of negative sentiment towards corporate actions. As seen with Coca-Cola’s lost sales following Israeli actions in the Palestinian Territories, these campaigns can impact sales and cashflow, and therefore represent a material risk to the performance of any investment in a company. Fund and investment managers may therefore wish to ascertain if companies are at risk of any links to conflict that might result in boycott campaigns against them.
Anther group of corporate stakeholders that can change their behaviour in light of links to aggressors and human rights abuses in conflicts is employees. Talent attraction and retention is an important objective for firms, given the costs associated with recruitment and the need to attract top talent in maintaining competitiveness. As reported by Co-operatives UK and the British Business Bank, younger generations within the labour pool are more likely to work for companies that act in ways aligned with their values, and so companies that are found to be linked to conflict in a negative way are more likely to face difficulties in this area.
Lenders and investors are also stakeholders that can react to corporate exposure to conflict in a manner detrimental to companies, which itself poses a risk to other investors. As seen with Norges Bank Investment Management’s divestment from Caterpillar due its links to Israeli occupation in Palestine, investors can - and do - act when companies are linked to abuses of human rights during conflict. Such loss of confidence by an investor (and certainly one as large as Norges Bank) poses risks to other investors in that it can drive company share prices down and generally impact market confidence in the company.
To Conclude
Exposure to conflict poses a real risk to investors, and the extent to which it does has only been briefly touched upon here. Here at Ethical Screening, we have experience in designing and implementing investment screens that are tailored to the specific needs of the client, including screens related to conflict risk and human rights abuses.
If you would like to know more about how we can do this for you, then please reach out to us at:
E: info@ethicalscreening.co.uk
P: 01242 539 850