Sustainable investing — the strategy and practice of incorporating environmental, social and governance (ESG) factors in investment decisions — is on the rise, but it is not as simple as it seems to be.
There are concerns that unscrupulous companies and fund managers are deceptively trumpeting their ESG ratings and accolades while making token gestures towards operating sustainably or implementing ESG investment processes. Because of the potential benefits that accompany ESG-alignment, greenwashing has emerged as its evil twin.
What is greenwashing?
Greenwashing is the practice of conveying a false impression or presenting misleading and exaggerated claims about environmental efforts. It results in investors being unable to allocate capital towards their goals and values, specifically those aiming to invest in sustainably operated companies or in sustainable funds. Greenwashing is becoming a growing concern as vast amounts of capital flow into funds that specialise in selecting companies viewed to adhere to ESG principles.
One notable company that is accused of greenwashing is H&M. H&M tries to be more eco-friendly by using sustainable materials for their clothes. However, this does not address the sheer amount of clothing produced as a fast fashion brand.
Why do companies and fund managers greenwash?
1. Larger demand than supply for ESG solutions. The current demand for ESG investment products still outweighs what can be offered by companies and the financial markets. There is an incentive for unscrupulous companies and fund managers to falsely package their offerings as ESG-oriented to meet this demand.
2. Lack of standardised ESG criteria or guideline. The proliferation of ESG reports and increase in public inquiries have led private organisations to come up with their own guidelines. Further, different reporting metrics and disclosure standards from ESG-setters, such as the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI), have created unintended confusion in the marketplace. As a result, industry players develop or select guidelines based on what is most convenient or advantageous to them as opposed to what will make the most meaningful impact.
3. Pressure and incentives from market consumers and non market actors (e.g., governments). There are motives to communicate positively about environmental performance to gain public favour and increase sales and market share. This leads to prioritising PR and marketing messages over substantive action.
What is the impact of greenwashing on ESG retail investors?
Greenwashing exploits retail investors' genuine environmental, social and governance concerns and limits their ability to make informed decisions. It also creates confusion and scepticism towards all organisations and institutions promoting green efforts.
Does greenwashing affect ESG funds?
Over the past few years, ESG fund managers have progressively found themselves under scrutiny for lip-service over their green credentials. In fact, 2 Degrees Investing Initiative found that up to 85% of green-themed funds were guilty of "misleading marketing".
This of course leads to the obstacle of clarity between consumer and fund managers' expectations over ESG-focused investment products. The popular iShares ESG Aware MSCI USA ETF is an example of a fund that has been accused of greenwashing. The fund simply tracks an index that negatively screens out companies in non-sustainable industry sectors.
As an "ESG fund" it does not actively endorse or vote on ESG company resolutions. According to Morningstar, iShares ESG Aware had 35 opportunities to vote for sustainability-related shareholder issues in 2020 but only voted in favour just 9% of the time.
3 ways to avoid greenwashing in your investments
Relying on recognised ESG standards
While there is no universal standard, there are certain well-established frameworks that help investors and financial advisors identify ESG products that are not guilty of greenwashing. One of the most stringent categorisations is the Sustainable Finance Disclosure Regulation (SFDR) developed by the European Commission. Under SFDR, financial market participants and advisors are required to evaluate and disclose sustainability-related data and policies at various levels. The classification of funds is divided into three categories, as laid out in articles 6, 8 and 9.
Our investment office uses the SFDR categorisation, among other frameworks and metrics, to screen for suitable ESG products. Consequently, our ESG portfolio comprises funds that are classified either under Article 8 or Article 9. Learn more about the Endowus ESG Portfolios here.
Choosing the best ESG fund managers
The average investor can rely on accreditation from third-party analysis services like Environment Finance to help with the selection process. The PIMCO Climate Bond fund, for example, won ESG Investment Initiative of the Year for Fixed Income in 2020. PIMCO's usage of proprietary tools to manage climate risk in the fixed income fund was one of the reasons it stood out from the many other fixed income products in the category.
Leveraging ESG expertise by an advisor
Working with an advisor that has in-house ESG capabilities can be of great value. At Endowus, we have the resources and expertise to conduct systematic analysis to identify the green from the greenwashed.
The Endowus Investment Office screens fund managers based on a range of frameworks and engagement reports. As part of a broader due diligence process, the team assesses how well a fund uses ESG factors in its investment process. Funds and fund managers are selected based on their ability to incorporate the right sustainability objectives into their investment decisions.
With all forms of investing, it helps to have a trusted advisor conduct the necessary analysis to build you a portfolio that is suited to your specific needs. This holds just as true for sustainable investing, perhaps even more so, given the additional complexity of ESG analysis. While greenwashing may be an industry challenge for the foreseeable future, it can be mitigated through partnering the right advisor. Please reach out to us if you would like to customise an ESG strategy for your portfolio.
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