Unmasking greenwashing: Are your investments truly sustainable?

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Additionally, Reuters (2023) reported a 70% year-on-year increase in greenwashing instances by banks and financial institutions worldwide.

In the investment universe, a study by The Economist found that the world’s 20 biggest ESG funds each hold on average 17 investments in fossil fuels, raising questions over the validity of their ESG claims. So, how do investors know their investments are ethical?

Getting to grips with greenwashing

The term “greenwashing” is not associated with money laundering or corporate espionage, but to misleading (and highly unethical) claims by asset managers that their fund(s) are environmental, social and governance (ESG) aligned, to try to attract investors.

With an increase in green marketing, investors are attracted to funds that may be presented as eco-friendly, natural, organic, and green without substantial evidence to support the claims. This industry jargon is intended to confuse the investor. Some funds use the ESG label but are invested in some of the world’s largest carbon emitters.

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So, how do investors know that their investments are green?

It’s wise to be wary and to familiarise oneself with common greenwashing ‘tactics’. Here are seven examples of how greenwashing may be hidden:

1. Hidden trade-offs: Claiming that a product/fund is green by looking at a narrow set of attributes and ignoring other important environmental issues, for example, technology promoting energy efficiency without disclosing the hazardous materials used in manufacturing.
2. Hidden trade-offs: ESG funds without third-party verification. Research needs to be conducted to verify the validity of these ESG claims.
3. Vagueness: For example, invested companies may claim to champion sustainability, including net zero initiatives, but they cannot provide evidence of it. It is important to use various reputable independent sources of information rather than to rely on information provided by the company itself.
4. Irrelevance/materiality: For example, making claims of environmental benefits that are unrelated to the environment or investing in funds that have no alignment to ESG, but have been included because of the sector where they operate. The investment manager could be doing this as a PR exercise.
5. Fake labels: Creating fake certification labels or endorsements from a third party.
6. Lesser of two evils: Selecting the least vulnerable stock in a high-risk ESG sector, such as fossil fuel companies. This can create a false sense of sustainability as fossil fuels are widely used and needed, and some believe that energy companies are both part of the problem and the solution.
7. Making false ESG claims: This can be assessed through the companies’ disclosure practices to determine if management was being transparent or merely adopting a short-term marketing strategy.

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What can be done?

Funds need to look beyond the green scores of their portfolios and instead look at investing in stocks that can improve their ESG scores. If the ESG scores only consider factors that impact the company and not how the company is impacting the world around it, managers and investors will miss the point of investing in change.

Managers should also put pressure on investee companies to invest in technologies that can drastically reduce greenhouse gas emissions. This requires highly selective, intra-sector capital allocation that favours climate change leaders.

As a result of greenwashing, some fund managers have failed to fulfil their investment objectives. There have been large discrepancies between their stated objectives and the reality of clients’ investments. Investment mandates must be clearly defined so that managers understand the importance of making accurate and transparent environmental claims.

While investors want to know about the return on their ESG investment, most also want to ensure that their investments will improve the world. Fund managers must provide detailed information about their investments, such as the environmental impact of these, including carbon emissions and resource usage.

Investors can drive the change they want to see

Investors need to remember that active shareholder engagement can drive change. Their investments in these funds can foster transparency and trust. Investors must hold managers accountable for their sustainability commitments and if any manager is found to be greenwashing, take appropriate action.

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A combined effort

With a proliferation of ESG labels and memberships, investors may find it hard to assess which ones are valid. Standardisation and adherence to certain basic minimum industry standards such as net zero, PRI principles, or the UN Sustainable Development Goals need to be regulated to make it easier to identify the many signs of greenwashing and remove them where appropriate.

There is also a fear that dropping/exiting a label for the right reasons could be misinterpreted as a fund not being ESG aligned. This will result in some managers losing out since they are unable to declare their funds as ESG or that their funds are not sufficiently ESG. Managers need to improve the quality of their reporting and show where they have been able to make a change through their investments.

Investors also need to understand that a good ESG score does not translate into a good ESG performance. Managers can deliver their ESG objectives as long as investors can clearly explain their expectations.

Adopting these practices will help to generate an environment of trust and legitimacy in sustainability efforts and contribute to the overall fight against greenwashing. Addressing greenwashing is an ongoing process that requires shared vigilance and dedication to ethical business practices.

We urge other asset managers to join us in taking a deep, deliberate approach to embed ethical sustainable investing practices in our deliverables, vision, and DNA.