However, with £124m a week on average placed into sustainable funds in the first nine months of 2019, there is an increased risk that products will not always do what they say on the tin.
The phenomenon of funds, or of individual companies in any sector, talking up their green credentials in order to attract capital is widely known as greenwashing.
Greenwashing occurs when ‘sustainable’ endeavours do not form a material part of the activities of the business Louis Florentin-Lee, Lazard Global Sustainable Equity Select StrategyKatherine Davidson, a portfolio manager for sustainable equities at Schroders, says: “In many ways we have gone from too little data to too much: firms now publish plenty of metrics, but with lots of small print.
“The key is to really read that, and then, if need be, to go back to the company and query anything with them.”
Key points
- Greenwashing is a danger for novice ESG investors
- This happens when 'sustainable' does not form a key part of the business activities
- It can be mitigated through research
The practices she notes includes companies promoting the sustainable activities of some of its subsidiaries, but not breaking down the overall activities of the parent company.
An example of this might be a large oil company that promotes the renewable energy business it has, but continues to invest in, and generate profits from, its traditional fossil fuel operations.
Louis Florentin-Lee, portfolio manager for the Lazard Global Sustainable Equity Select Strategy, says: “For us, greenwashing occurs when ‘sustainable’ endeavours do not form a material part of the current or envisaged future activities of the business, or when they are undertaken without a profit motive.
“In these circumstances, they may be construed as token gestures.”
He adds: “We are interested in companies where the move to a more sustainable world is positively impacting their ability to generate profits.
“We believe that consumers, governments and businesses want to transition to a greener, healthier, safer and fairer world.
“In doing so, this will materially impact the demand for some companies’ products and services.”
Fundamental conditions
Mr Florentin-Lee says: “In order to form part of our sustainability portfolio, a company must meet two fundamental conditions: firstly, a ‘sustainable’ company is one that can take advantage of these shifts in demand by offering products or services that will facilitate that transition; and secondly, the company must do what it can to minimise the negative externalities that their business creates.”
He says it is important that both conditions are met. It is not enough for a company to ‘offset’ the negative impact of its business through charitable or environmental donations elsewhere.
Equally, he adds, a business selling the most environmentally friendly products needs to manage their business and supply chain responsibly.
“An oil company does not qualify as ‘sustainable’ just by donating money to some of the communities in which it operates; neither does an electric vehicle company if it uses child labour in its supply chain.”
David Winborne, a fund manager at sustainable investment specialist Impax, says the task of assessing whether an investment is truly sustainable can be divided into two: one task is about the products or services the company produces, and the other about how the company runs its own affairs.
He says: “The first is to rigorously analyse how individual companies’ business activities may fit into the transition to a more sustainable global economy, both in terms of opportunities and possible risks.
“The second is to examine how these companies approach their own environmental, social and governance structures to develop a sense of how a firm conducts itself.
“Taken together, this is the ‘what’ (sustainability alignment) and the ‘how’ (ESG practices) of the investment process, which is a common feature embedded across all Impax investment strategies.”
Hard work avoids greenwashing
Craig Bonthron, co-manager of the Kames Global Sustainable Equity fund, says: “The only way to keep the fund free of greenwashing is through hard work.
“We do our work by looking from the bottom up at what these companies are doing. You find that some of the very large companies that talk about their commitment to sustainable investing are actually spending more on lobbying than they are on sustainability.
“We like a company called Kingspan, which does insulation; it is very clear what it does and the impact it has, which is to remove carbon.
“Whereas we think some of the traditional car companies, for example, have too many competing priorities and so won’t invest in them. We like Tesla, and have owned it for a long time, as it is very clear what it does.”
Problem of diversification
Mike Fox, who runs the Royal London Asset Management Sustainable Leaders fund, says the challenge to be properly sustainable in how one invests is similar to the challenge active fund managers of any kind face to provide investment returns.
He said: “Generally speaking, the more diversified you are, the worse it is.
“That diversification in a portfolio, if it goes too far, is a negative.
“And I think the same applies in a sustainable portfolio; more diversification is likely to make it worse, that is, less sustainable.
“The first thing I would say is, if you are calling your fund global equities, then it cannot just be about Europe and the US. What we try to do is focus on a few areas – chemistry, engineering and energy, for example – and be as global as we can.”
He adds that despite all of the capital that has gone into the sector, sustainable funds continue to represent less than 3 per cent of the total of all assets managed within the various Investment Association sectors.
Screening a company’s green credentials
David Harrison, a fund manager on the Rathbone Global Sustainability fund, says: “We only want to own companies that can walk-the-walk in terms of sustainability.
“We use the UN sustainable development goals as part of our framework to achieve this, but also have a very detailed process in place, and work with our colleagues at Rathbone Greenbank Investments to screen securities.”
He says Rathbones looks at data, but also engages with management teams to understand a company’s sustainability credentials.
“Are financial goals linked back to sustainability ambitions? How is management compensated – is there a clear link to sustainability? How does a company manage its workforce, its supply chain and how does it contribute to wider society?,” he asks.
Mr Harrison says the team spends a significant amount of time finding answers to each of these questions and there needs to be a “very clear sustainability investment process in place – in our case, Rathbone Greenbank Investments has the final say on whether we can buy a company or not.”
He adds: “The fund manager has the investment input, but is not the ultimate decision-maker in terms of sustainability credentials.”
Michael Crawford, chief investment officer at Chawton Global Investors, says a company should be sustainable as a business if it does not need to borrow excessively, while if it is to have a sustainable impact on the wider world, it must not deplete natural resources.
He says those goals are complementary, rather than mutually exclusive.
Mr Crawford says: “These objectives are often mutually supportive; for example, companies that damage the environment often deploy heavy fixed assets such as fossil fuel extraction, auto and aerospace factories.
“The asset intensity leads to lower returns on capital. In practice, we end up with a portfolio that, in aggregate, is asset-light where high returns are underpinned by the competitive advantage from brands, patents, engineering innovation, digital networks and scientific innovation.”
David Thorpe is special projects editor at FTAdviser and Financial Adviser
