Greenwashing has become a major issue as firms attempt to hop on the ESG bandwagon. One study found that greenwashing was the biggest concern for 44% of all ESG investors, with this number rising to 56% for sustainability-linked bond investors. For investors to learn how to avoid greenwashing, it is critical to dig into the root causes and grasp the prevalence of greenwashing in the industry.
The Impact of Greenwashing
Kelly Gibson, chair of the SEC’s ESG Task Force, defined greenwashing as “exaggerating” a “commitment to, or achievement of climate…related goals.” The mainstreaming of ESG has changed how companies factor sustainability into their decision-making, creating incentives for them to make themselves and their products more sustainable than they potentially are.
A study commissioned by As You Sow, the shareholder advocacy group, found 60 of 94 ESG funds failed to closely stick to the core principles of ESG investing. Morningstar also recently slashed the list of European funds it recognizes as sustainable by 27% as many failed to meet the criteria. Against this backdrop, it makes sense for ESG-motivated investors who are concerned about avoiding greenwashing to do some due diligence.
Clarify ESG Investment Goals
Before investors begin to consider the merits of the various funds that are branded as ESG, they may want to first confirm their own ESG goals. For instance, are they looking to invest in a broad ESG fund or are they looking for specific thematic exposure within ESG, such as a fund focusing only on climate change? Are they happy to invest in stocks that are making a transition toward green energy, which may also have legacy brown businesses, or do they just want to invest in the so-called pure-play green energy stocks?
Just because a fund has ESG in its label does not mean it will meet an investor’s expectations on ESG.
Analyze the Fund’s Focus
The top 10 holdings listed on the fund’s fact sheet can be quite telling. Investors should be able to find information on sector breakdown for a fuller picture of the fund’s industry focus. It is also worth comparing this information with other ESG funds. Investors could read the fund’s marketing information to get an understanding of the investment philosophy and process. For example, if an investment company says it “integrates” ESG into the investment process, then it is claiming that ESG is a driving force for its investment decisions. Conversely, if the firm says it “considers” ESG, then this suggests ESG is afforded much less importance in stock selection and asset allocation decisions.
Review the Fund’s ESG Reporting
Investors could ask the fund manager for monthly or quarterly investment reports. These could shed light on ongoing portfolio decisions, investment strategy, and how the investment firm measures impact. It may also demonstrate how ESG is shaping the portfolio, why some stocks have been exited, and why others have been chosen. The investment manager may also reveal efforts to get the companies invested in to improve their ESG scores. It is a good sign when this sort of information is included in regular fund reporting as it indicates the fund manager is taking ESG seriously and engaging with company management on ESG issues. It may be worth doing a bit more research on any underlying investments mentioned to understand if they align with ESG goals.
Examine the Fund’s ESG Credentials
Investors could take a look at the ESG ratings for funds that are held by third parties like Morningstar or MSCI. For example, Morningstar’s Sustainability Rating for Funds is meant to provide a snapshot of how well ESG risk is managed at a fund level relative to its peer group. Furthermore, learning how to avoid greenwashing means recognizing that ESG labels on funds do not represent what you expect them to. As with any impact investment, ESG due diligence is a must to make sure the desired results.