The burning question for ESG funds: Do they inhale?
Horizons ETFs CEO Steve Hawkins recognizes Canada is stuck in an “investment quagmire” when it comes to responsible investing.
The process of determining what stocks should or shouldn’t be included in funds that adhere to environmental, social and governance concepts ultimately comes down to the interpretation of an asset manager, Hawkins said. And each one is different.
It’s the space’s fundamental flaw, he said, and nowhere is it more pronounced than when it comes to the cannabis industry.
“Everyone is interpreting ESG differently,” Hawkins said. “I think cannabis continues to raise a lot of red flags for a lot of different people but it’s also in one of those very, very big grey areas of should it be considered ESG or socially responsible from an investment perspective.”
The debate is perhaps best illustrated by the approaches two of Canada’s biggest financial institutions have taken on the subject.
Last week, Bank of Montreal launched a new suite of ESG ETFs based on MSCI indices, including a Canada ESG leaders fund that counted three cannabis stocks — Cronos Group Inc., Canopy Growth Corp. and Aurora Cannabis — among the 40 in its portfolio.
The Royal Bank of Canada, meanwhile, performs negative screens against cannabis to ensure these same companies are automatically excluded from its responsible investing Vision mutual funds.
I think cannabis continues to raise a lot of red flags for a lot of different people but it’s also in one of those very, very big grey areas
Horizons ETFs CEO Steve Hawkins
An RBC spokesperson said that negative screens are performed by Sustainalytics, a third-party group that provides ESG scores to asset managers. The main issues the group has with cannabis is that it doesn’t differentiate its revenue from recreational use and medicinal use.
“Due to this, Sustainalytics ratings include cannabis companies in the same category as tobacco, which makes them ineligible for inclusion in these funds,” the spokesperson said.
BMO did not reply to an interview request prior to publication.
The discussion is a complicated one. Several Canadian cannabis companies have already been caught playing fast and loose with regulations, meaning they would likely score poorly in the governance portion of an ESG test.
On the environmental side, there are concerns about the amount of water cannabis companies use, the waste they produce and the energy they consume. But the industry is improving on environmental issues, according to Hawkins, who said companies such as Hexo Corp. and The Green Organic Dutchman Holdings Ltd. are moving further toward using sunlight to grow their product.
Cannabis, however, scores well in the social category because of its medicinal value to treat everything from pain to epilepsy.
From Hawkins’ perspective, the pros outweigh the cons and should be sufficient to see cannabis included, especially when some asset managers are willing to place oil and gas stocks in their ESG funds.
Horizons’ Global Sustainability Leaders Index ETF does not include cannabis, Hawkins said, because it focuses on the 500 largest companies in the world by market cap.
Outside of RBC, Fiera Capital also performs negative screens on cannabis in six funds. Desjardins, meanwhile, holds Canopy Growth Corp. in its RI Canada Low CO2 Index ETF. But the majority of Canada’s institutional players appear to be in a holding pattern: They haven’t blocked cannabis stocks from their funds, but they also haven’t included them.
NEI Investments manages 17 responsible investing mutual funds in Canada and none of them holds a single cannabis stock. David Rutherford, vice-president of ESG services at the firm, described the firm’s stance on cannabis as that of a watcher. The environmental and governance risks associated with the sector are too great to invest in them at the moment, but that can change as NEI continues to monitor it.
“We’re watching and we can afford to watch because not one of our sub-advisors has expressed an interest in investing in these companies,” Rutherford said.
Even if cannabis did rank highly in ESG assessments, it would still have to prove to be a profitable investment before being considered for inclusion, NEI chief investment officer John Bai added. Namely, the companies would have to demonstrate that they have sustainable business models and the stocks would have to become positive contributors to investor returns.
“If a company is an A+ on E, S and G but from a financial standpoint, we think this will return -10 per cent over the next five years, it would not make it into our portfolios,” Bai said.
The cannabis industry must also overcome the fact that it is often lumped in with sin stocks, said Sucheta Rajagopal, an investment advisor who builds responsible investing portfolios that include cannabis at Mackie Research. The comparison to alcohol and tobacco is an easy one to make and Rutherford said it is common among religious and values-based investors. From an institutional perspective, RBC and Sustainalytics have also grouped them together and even NEI compared cannabis to tobacco and alcohol in a 2018 report that looked at its potential ESG value.
“They’re not thinking of the way cannabis is used today,” said Rajagopal, referencing oils, beverages and edibles. “They’re thinking of smoking.”
Cannabis companies will have to surpass all of these barriers to be granted widescale inclusion in ESG portfolios. It’s a priority for them — a group of 45 companies called the Global Cannabis Partnership is working together to achieve that goal. These companies are starving for institutional funds, Hawkins said. Finding their way into these portfolios could be the key to unlocking the capital that some banks and pension funds have refused to invest directly in them.
“I really hope we’re still not having the exact conversation in (five years),” Hawkins said. “A significant portion of society has started to shift on how it views cannabis and I think that’ll continue going forward.”