Sustainable Investing and ESG is big business. Surveyed investors say they integrate ESG into at least 75% of their portfolios and total funds invested in some form of ESG asset are expected to exceed $50 trillion by 2025. With potentially up to 90% of people today believing that sustainability is important when investing, we’re starting to see mass adoption of these strategies.
The mass market push has led to an increase in Companies, Brands and Investment products promoting themselves as green and / or ethical. With increased adoption comes increased scrutiny of these claims and resulting in an increase in identification of greenwashing. And this is where financial advisers can play a crucial role with clients.
While there is no uniform ‘ESG law’ in Australia, fund managers must follow statutory requirements relating to the promotion or offer of sustainability-related products. I.e don’t overstate what the fund does and in this case, how ‘green’ it is. Similarly companies are bound in part by the advertising standards when it comes to adverts and statements about how sustainable they are.
It is widely anticipated that Australia will mirror recent changes proposed in the US and the European Union where there is a crackdown on companies that use ESG as a marketing ploy to exploit investors’ best intentions.
So how can investors know if their ESG funds align to their social and environmental values?
What Is Greenwashing?
Greenwashing is a marketing tactic that companies use to lure in environmentally conscious customers, despite their products or services being anything but. When businesses represent themselves as sustainable by providing false or misleading information about their practices, that’s greenwashing. Specifically for investing, the Australian regulator, ASIC, describes greenwashing as the practice of misrepresenting, in the context of funds management, the extent to which a financial product or investment strategy is environmentally friendly, sustainable or ethical.
These sorts of claims can range from a Big Oil company running ads showcasing how they help protect endangered species to a Fund Manager claiming their portfolios are free from such things as Tobacco or Animal Testing, when in fact they are not…more on that later.
Greenwashing and ESG Investing
The principle of sustainable, responsible, ethical investing is nothing new and has been prevalent in our society for hundreds of years in one form or another. Today we’ve seen a rise in data led strategies that rely on ESG data (Environmental, Social and Ethical) to help construct portfolios and help align investments to client’s preferences. In its simplest form, investments that have high ESG scores are deemed ‘good’, whereas ones with low scores are deemed to be ‘bad’.
A 2021 report by Morningstar found that Millennials, Gen X and Boomers all had similar preferences for owning sustainable investments. With this, Greenwashing has become an increasing issue for ESG. In 2021, The Economist studied the world’s 20 biggest ESG funds; it found that each of them held investments in fossil-fuel producers, while others held stakes in oil producers, coal-mining, gambling, alcohol and tobacco.
In the eye of the beholder. Sometimes.
When it comes to an individual, or ‘retail client’s’ attitudes to ESG investing, this is where the problem is starting to become apparent.
At a company level, alignment to someone’s investing preferences and perceived greenwashing is often pretty clear cut based on an investor’s attitude to a company or industry. If an investor wants to avoid any and all involvement in Fossil Fuels, it is clear their attitude toward a company operating in, or adjacent, to that industry either directly, or in the supply chain, should be avoided – simply in the eyes of that investor, the damage caused to the environment will far outweigh the potential investment return an the work that company may say it’s doing to protect endangered species.
However when it comes to the attitudes of a Fund Manager things may differ. Fund Managers are prone to using ‘thresholds’ to allow exposure to certain areas, such as Tobacco, Fossil Fuels, or Weapons, as long as the exposure is less than a certain percentage of the portfolio, or if the Holding makes less than a certain percentage of revenue from that particular area – if these thresholds are not met, Fund Managers confidently state that are ‘Free’ from these areas. More often than not, a retail client will not agree.
Another watch out is the application of ESG ratings to traditional, non ESG Funds to use as a risk management tool. This is an ESG Integration strategy. Recently described as “Ballyhoo verging on the baloney” by the Economist, ESG Integration creates possibly the largest gap between fund managers and customer expectations as often the Fund Manager decisions are risk based, not Sustainability based.
The role of Advisers
Whatever an Adviser thinks of ESG, Sustainable or Responsible Investing, it is clear that it will not go away anytime soon, and nor should it. It is an approach that can play a role in creating a more environmentally friendly and equal society by rewarding good companies, without necessarily sacrificing investment returns, and importantly it’s what clients overwhelmingly want.
No two clients are the same. This is true when it comes to how a person sets their financial goals, or assesses their attitude towards investment risk. So too is it true when it comes to Sustainability.
This provides a fantastic opportunity to for Adviser to use their foundational expertise in assessing a client’s needs, research and product recommendation to help find solutions that a) avoid the stain of greenwashing, i.e source true ESG and Investments that do what they say they do when it comes to being gree and b) align different investments to different clients needs.
How Advisers can Assess ESG Investments
There are an increasing number of ways for clients to scrutinize their investments, but the Adviser space has a little catching up to do. That said there are some great tools and resources out there that can help any Adviser as they become increasingly engaged in this topic.
Online Tools to Assess ESG Funds
RIAA is an independent body with a strong mission to promote, advocate for, and support approaches to responsible investment that align capital with achieving a healthy and sustainable society, environment and economy. They provide certification to Funds and Funds Managers giving them the RIAA stamp of approval that they adhere to the RIAA mission and criteria.
Ethic Adviser is an independent company that aims to empower Advisers to be sustainable investing specialists. They offer powerful tools that help Advisers determine a client’s Sustainable Investing needs, conduct research from a global universe of investments, including most Funds and ETFs, as well as provide other advice support tools such as Comparison tools, Insights, and Compliance tracking. As their system analyses companies, and funds at a Holdings level, this is one of the best tools around to help identify misalignments with a client’s needs and greenwashing.
Ethical Invest Group is independent training and consultancy specializing in helping Financial Advisers to learn about and gain the practical tools to provide every aspect of Sustainable Investing advice. The Ethical Advice Accelerator is an online program for Advisers, combining comprehensive education with real-world application of ESG, sustainable finance, and values-based advice. Helping Advisers upskill in sustainability and responsible investing.