How to do ESG due diligence and avoid greenwashing in portfolios

This article is part of
A guide to ESG and responsible investing

How to do ESG due diligence and avoid greenwashing in portfolios
David Gray/Bloomberg

In fashion it is generally the case that whenever something becomes trendy, imitations appear, many of which are inferior to the original.

This applies to the investment management world as much as to anywhere else. 

The story of recent years has been the emergence of investment products with a focus on environmental, social and governance (ESG) concerns. 

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And as with any trend, there has been a substantial increase in such products coming to market.

The increased desire of many clients to have their money managed in a way that has a positive impact on the world, combined with the strong performance of ESG funds in the pandemic-induced sell-off of March 2020 has drawn in many investors attracted by the favourable returns. 

Asset managers, hindered in their growth plans by the popularity of passive investing, and volatility of markets, have alighted upon ESG mandates as a way to drive inflows.    

Advisers and wealth managers looking to ensure the portfolio into which they place their client’s capital is sustainable are thus likely to be faced with a range of new offerings.

And a decision on how to identify those which genuinely are about ESG, rather than merely using the term as part of a marketing strategy, needs to be made.  

Matt Evans, sustainable equity fund manager at Ninety One, says although there are many ratings agencies to grade funds according to ESG criteria, there also has to be "an element" of personal responsibility on behalf of the provider.

"I think where there has been a lot of fund launches and fund literature where the managers talk about how ESG is 'embedded in their process and has always been’ but I don’t think those are really ESG funds.”

Francois De Bruin, a fund manager at Aviva Investors, says the ability of a product provider to supply data to back up the claims made about the ESG credentials of the portfolios they manage is key to him understanding whether the company is truly ESG compliant. 

He says: “If the data is there then it is very clear cut, and if it is not there, then it is also clear cut.”     

According to Mona Shah, an ESG fund picker at wealth management firm Stonehage Fleming, everyone has a different definition of sustainability, but some fund pickers just look at the largest holdings and base it on that. She says: "I want to see all of the holdings in an ESG fund, and then I need to know that their definition of ESG aligns with mine.” 

Greenwashing is a genuine problem for fund pickers to monitor, says Nicolo Bragazza, investment analyst in the portfolio management team at Morningstar, because some investment firms and the companies in which they invest are becoming more aware of the need to be seen to compliant, presenting a challenge for an investor, to ensure thy only invest with the firms that are truly following the rules.