Should you buy bad companies?
Written by:
Roddi Vaughan-Thomas
Tatton Investment Management
One of the most enduring questions in ESG investing is whether to avoid companies with poor ESG credentials or invest in them to drive improvement. The answer depends on your perspective – and why you apply ESG principles in the first place.
ESG investing isn’t really one style; it spans several strategies. In 2024, the FCA introduced labels to help UK fund managers clarify these styles:
- Sustainability Focus: At least 70% of assets meet credible environmental or social standards.
- Sustainability Improvers: Managers aim to improve unsustainable assets through shareholder engagement.
- Sustainability Impact: Investments target projects or companies that materially improve the world.
- Sustainability Mixed Goals: A blend of the above under SDR rules.
The distinction between Focus and Improvers highlights the classic debate: should ESG investors exclude poor performers or buy them and push for change? Put simply, should you buy bad companies?
It’s about perspective
Neither strategy is clearly superior for maximising returns. One might worry that improving ESG metrics through shareholder engagement could undermine the sources of return – like an activist investor ridding an energy company of its profitable oil operations.
Engagement can backfire too. ExxonMobil recently sued activist shareholders over ESG resolutions (the case was dismissed). The oil major now uses a system aligning retail votes with its board, limiting activist influence.
Conversely, excluding “bad” companies can mean missing out on profitable opportunities. Outcomes depend heavily on context.
Improving ESG metrics is challenging. Engagement faces resistance, but avoidance alone rarely changes behaviour. In theory, if access to capital depends on ESG compliance, both strategies exert similar pressure. For any company, effectiveness depends on whether it responds more to shareholder votes or market forces.
Policy Perspective
Ideally, both approaches should coexist. To promote widespread ESG adoption, investors need both:
The carrot: Capital for companies willing to change.
The stick: Avoidance of non-compliant firms.
Personal Choices
For individuals, a mixed strategy may make sense. Diversification applies to ESG risks as much as financial ones. But ESG investing is tied to personal values: even if engagement works, you might avoid sectors like gambling or weapons on principle.
So is avoidance or engagement best? This is an age-old ethical debate, and not one that investment professionals should pretend to have any special answers to. Excluding bad companies could be seen as sticking to your principles, or it could be seen as sticking your head in the sand. Engagement could be seen as trying to make real change, or it could be seen as being complicit in unethical behaviour. Deciding which view to take comes down to whether consequences or principles are more ethically valuable – whether the ends justify the means.
Tatton’s Approach
That is why Tatton doesn’t have set rules on which ESG strategy is best. For our Ethical Portfolios, we have certain negative screens against ‘no go’ industries, because that is what our own survey data suggests our clients care about most. Additionally, some of the funds we invest in will have methods for positive engagement – whether those are of the impact or improvers variety.
We don’t tell fund managers which strategy to pursue. Rather, we look thoroughly at their processes and assess whether they match up with what matters to our clients. As ever, this needs to be done consistently and with full transparency. ESG investing is about investing according to your principles – so it’s important to make sure those principles are indeed yours.