How to spot greenwashing

So what is greenwashing and why does it matter in the world of ESG?

Greenwashing

Mihir Kapadia, chief executive of Sun Global Investments, says greenwashing is “the process of companies engaging in marketing or public relations strategies to appear aligned with ESG objectives”.

Nick Henderson, portfolio manager in the responsible global equities team at BMO Global Asset Management, says: “Greenwashing can be a problem, as many firms see that there are benefits to being seen in a positive light from an ESG perspective.”

Key Points

• Greenwashing is becoming a thing, now that ESG investing is more popular
• Advisers should beware funds that simply call themselves ‘ESG’
• The Investment Association is trying to create a standard for ESG investing

He adds: “That places a heavy burden on fund managers when meeting and assessing companies to critically analyse each company’s approach to ESG and whether or not it is greenwashing.”

Third-party providers of reports and ratings assess many international and domestic public and private companies on their ESG performance. 

Financial institutions, asset managers and other stakeholders typically rely on them to measure company ESG performance compared with peers. 

Paradoxically, many in the industry stress that while ESG ratings often trigger fund managers to identify ESG opportunities, they also contribute to greenwashing. 

ESG ratings 

Report and ratings methodology can vary greatly from provider to provider. 

Eoinn Murray, head of investment at Hermes Investment Management, says:  “A large part of the problem associated with ‘greenwashing’ comes from a willingness to focus on aggregate ESG ratings – ratings have their place, but the scale of disagreement between different rating agencies is a clear indication that they should not be solely relied upon.”

ESG rating providers range from standalone shops such as Vigeo Eiris and Sustainalytics to larger index providers like FTSE Russell, Bloomberg ESG Data Services and DowJones Sustainability, to name a few. 

Mr Murray says: “It is easy enough to build a portfolio loaded with ‘green’ stocks/bonds that is designed to achieve a high rating, but is far more of a challenge to dig down into the details of what actually matters.”

He adds that historical data underpinning ratings should only be used as a guide, and true responsible and sustainable investing has to be “thinking about the strategy a company has for delivery of future earnings and cash flows”. 

But Alice Evans, co-head of responsible investment at BMO Global Asset Management, points out many standardised reporting methods and initiatives exist that can help improve the clarity of ratings. 

These include:

• The Global Reporting Initiative is a global independent standards organisation that helps governments, organisations and businesses understand issues such as climate change, corruption and human rights.
• Sustainability Accounting Standards Board helps businesses around the world identify, manage and report on sustainability topics. 
• The World Benchmarking Alliance focuses on seven systems transformations to develop benchmarks to identify keystone companies whose contribution is vital to achieving sustainable development goals. 

Ms Evans also highlights that the UN Sustainable Development Goals and their sub-targets provide a useful framework. 

Just paying lip service? 

The greenwashing problem begs the question of whether fund managers are simply adding green stocks to their funds or whether they are actually generating a social impact. 

Mr Henderson says there is a divergence within the fund management industry between those who are fully embracing sustainability and those who are not. 

He explains that the level to which fund managers are fully embracing ESG stocks, or merely paying lip service, can perhaps be evidenced in the core philosophy of the fund and in their fund reporting.

“Does the fund manager have the capability and track record to execute a fund philosophy to address global sustainability, and are they able to demonstrate that in the reporting of the fund?

“Reporting must go beyond simply: what are the top 10 holdings? They must include: what are all of the holdings and are how are they addressing sustainability challenges?” 

Mr Kapadia echoes this view: “ESG issues are long term, and investors are at the beginning of a long journey. Even those people committed to the destination cannot go too far as their competitors may have a more short-term strategy.”

He expects ESG stocks to become more of an approach or philosophy of investing as companies are having to change strategies to balance investors’ interests. 

Alan Chan, chartered financial planner and director at IFS Wealth and Pensions, disagrees with the view that fund managers are under pressure to add green stocks to their portfolios. 

He says his company adopts a stringent criteria when selecting ESG or ethical funds, including a minimum track record three years and the minimum size of the fund. 

How to prevent greenwashing

Mr Kapadia says: “Self-regulation won’t be the full solution, but enhancing overall transparency by industry actors themselves will support the prevention of greenwashing.”

He adds: “This should include reporting about the level of ESG integration in the firm, the investment and engagement process and its underlying policies, holdings, voting guidelines and their results, impact measurements as well as external consultations, assurances or verifications.”

Mr Chan suggests the industry should agree on a common definition and framework for ESG investing to ascertain minimum standards. 

He says: “[The industry could have] perhaps even an ESG ‘kitemark’ awarded by a professional body to show that [a company has] met the required standards and is reviewed regularly.”

The Investment Association, the trade body for open-ended funds, launched a consultation on sustainability and responsible investment in January this year. 

The consultation closed on March 1 this year. 

The consultation intends to create a voluntary UK standard for ESG funds, which the IA hopes will provide greater clarity to investors to understand the nature of the product in which they are investing.

Ashley Hamilton Claxton, head of responsible investment at Royal London Asset Management, says:  “[ESG is] definitely a ‘buyer beware’ market, and consumers and investors need to do their due diligence to make sure their investment choice suits their needs.”

She adds: “Don’t simply rely on the fund name to guide your choice, as sustainable/ethical/impact all mean different things to different people; it’s much more important to look at the detail of what each fund is trying to achieve.”

Saloni Sardana is features writer at FTAdviser and Financial Adviser