Investing in ESG has a lot of skepticism among investors. Why? Several factors undermine investor confidence in ESG scores, indexes, funds and portfolios. Some say sustainable investing is nothing more than a marketing ploy or a PR stunt. The main problem again is that there is no clear, consistent way to produce data to evaluate ESG policies and investment strategies.
A lack of oversight, especially in countries like the US together with the increasing popularity of ESG investment often leads to "greenwashing," when firms promote their products as environmentally friendly when in fact they are not. The term "greenwashing" originates from blending the word "whitewashing," which is the use of misleading information to cover up bad behavior. In the investing world greenwashing allows firms to profit from labelling their funds ESG compliant, while only committing themselves to superficial social responsibility.
Here are a few examples of greenwashing! Let’s say a company says its fund is ESG compliant just because it excludes obvious sin stocks, like pot stocks or the shares of tobacco companies and weapon makers from its portfolio, while it doesn’t apply any other ESG factors to the rest of the holdings. Or how can asset managers explain why they are having oil and mining companies in their portfolios?
The reason why they can get away with it is that there are no clear standards on how financial products should be named and marketed. Several asset managers who advertise their products using terms such as ESG and sustainable fail to explain to investors what exatly they mean by that. Others are repurposing existing funds into ESG funds without really changing the stock selection through incorporating material ESG factors.
Seeing the huge demand for ESG products, some investment companies try to convince their clients that high ESG ratings can translate to better financial returns. However, there is insufficient evidence that ESG investments deliver superior risk-adjusted returns. As with any investment, you could even lose money investing in an ESG fund.
Another problem is that investing in funds that consider ESG may be a lot more expensive than other funds that do not consider ESG factors. It is important to understand the fees and expenses you are required to pay for the fund, and compare them to other investment options.
How can you assess the ESG contribution of ESG funds?
We put together a checklist to help you pick a fund that truly complies with ESG requirements.
- Look at the fund’s prospectus. ESG factors must be central to its investment strategy and the fund has to be clearly committed to being a sustainable investment. This intent should be stated in the fund’s prospectus. It is not enough to be vague and just say that fund managers may consider some ESG factors at some point in their investment decisions.
- Check if ESG is a core component of the investment selection, or is it just one of many factors that are considered to select investments.
- Analyse how the fund incorporates each of the three ESG factors within its ESG portfolio.
- Compare the fees and expenses to that of other, non-ESG investment products.
- If someting is still not clear, ask your fund manager to give you more information!
- Read what our experts say about how investors can assess the ESG contribution of ESG funds