Understanding Greenwash

Posted on: November 13th, 2019

Understanding Greenwash

Recent media coverage, generated in part in response to a recent report by SCM*, indicates that greenwash fears are growing apace.

This is of course a huge shame as when we talk about funds that focus on environmental, social and ethical issues we would all much rather be talking about their benefits relative to their ‘vanilla’ peers – but that is no reason to dodge the issue.

The following tips respond to the points made in the report and related media coverage in the Sunday Times, FT Adviser, Professional Adviser, Last Word Media and elsewhere.

This is in bullet form (with key words highlighted) as we are all time poor – but please do not interpret this as my glossing over the importance of this subject.  My intention is to have the opposite effect as this matters…

  1. Before recommending an ESG, sustainable, responsible, impact or ethical investment fund it is important to know what that fund does. Intermediaries (be they a platform or an individual adviser) need to know both the issues that the fund considers and how the fund approaches those issues.  If there is no information of this kind available a fund can not be sensibly be regarded as being having strategies in those area and so should not be considered to be a fund with ethical, ESG or similar strategies.   The filter options,  text and links on Fund EcoMarket are designed to enable users to do research of this kind – all information is supplied directly by fund managers and published ‘verbatim’).
  2. As such, if a fund does not explicitly say it avoids or supports a particular activity or type of company then an intermediary should not recommend (or select) it on the basis of what it does in that area… as that is not known.    (So, for example if a fund does not say it avoids tobacco, armaments manufacturers or companies with poor environmental practices you can not expect it to do so even if such companies are not currently held).  This is notably different from ESG ratings which have their own assessment criteria, typically based on a snapshot in time, typically assessing holdings based on data rather than paying attention to fund policies, aims, objectives etc.
  3. The top priority for identifying ‘appropriate’ funds is ‘matching clients’ aims to fund strategies’.  This  can only be driven by identifying what a client wants.  And client needs vary… intermediaries may agree with some and disagree with others – that is not relevant.  Understanding clients needs comes down to fact finding .  Support on this is available on the Fund EcoMarket help area and via our SRI StyleFinder tool.
  4. A further priority for many/most is to consider the science – particularly around climate change –  and in particular to recognise the direction of travel it is likely to trigger as this feeds through into the business case for investment.  (See Intergovernmental Panel on Climate Change, IPCC) – but be aware – other areas like biodiversity are also crucial.  Scientific research is increasingly driving regulation, business behaviour and therefore investment decision making.  This is relevant to individual investors as well as pension schemes and other big investors.  To expand on this a little – if we are to reduce carbon emissions we need to emit less carbon… which is bad news for carbon hungry industries and good news for cleaner, greener and more efficient companies.   (The Bank of England has done much excellent work on how climate change is threatening financial stability and their TCFD  framework is increasingly being adopted by banks.  Governor Mark Carney’s  2015 ‘Tragedy of the Horizons’ analogy is particularly useful for framing the situation we are now in.)
  5. The regulators are aware of greenwash – and are on the case.  However their role is not easy.  In this area – more than most – they are effectively  ‘damned if they do damned if they don’t’.  The last thing we want is regulatory bodies strangling innovation in this field – but miselling and the reputation also matter, as does the misallocation of capital.  They therefore need to tread a fine line – as they are doing  (exemplified in their recent climate change consultation feedback statement) ,  which I hope will now evolve rapidly.  Underpinning their actions are related longstanding requirements such as intermediaries needing to not mislead people and providers needing to publish all relevant information – so irrespective of future changes there is plenty of scope for more regulatory action if deemed necessary.
  6. Change is coming – probably.  The EU’s growing recognition of the importance of sustainable finance means that the intermediary market should already be anticipating changing requirements as part of MIFID II , (via  ESMA – which we are supportive of)  this particularly relates to fact finding and intermediary support processes.  But don’t hold your breath.
  7. Linked to the above – it is true that there are currently no rules or regulations governing what is and is not ‘ethical’ –  thankfully so in my view!   Newcomers to this area often think it would be easy to set rules but consider for a moment how we might align ‘rules’ to suit the following:  faith based investors – including those wishing to invest in line with Shariah Law, people with animal rights concerns & vegans, healthcare professionals, those who oppose oppressive regimes, people who fear local job losses – and  (gender and other) diversity enthusiasts – and that’s before we mention Greta Thunberg and Extinction Rebellion sympathisers and supporters.   To tie this down too tightly would risk it being ridiculed,  whereas to defining it too loosely would risk ‘gaming’ or worse.  Assuming we wish to treat people as adults this largely points back to the need for improved transparency and better factfinding (ie KYC as was) – as well as perhaps the usefulness of some additional governance and verification.
  8. Setting ‘standards‘ is however potentially  easier and more fruitful as a fund could either ‘meet’ or ‘fail’ a given set of  criteria (that they could opt in or out of) without  the fund becoming obsolete.  As such standards are very different from regulatory requirements (which are not optional) and therefore have the potential to facilitate market expansion without compromising innovation.  This is why I support the BSI’s ongoing work in this area. (Standardisation has been shown to help facilitate ‘scale’ – which is much needed if we are to address the our collective failure to incentivise investee companies to significantly raise ESG standards).
  9. Recognise that the ESG, SRI, sustainable responsible and ethical investment market is a spectrum – a broad church –  if you prefer.  We often use the term ‘necessarily diverse’ – as it has evolved to meet different client aims and maximise different opportunities.  Although there is agreement on many issues none of the areas considered by these funds are truly binary.  Funds rightly have different strategies and aims – some being pretty close to ‘vanilla’ funds, others being clearly different (which collectively should also help guard against the risk of bubbles).
  10. There is much discussion about the need for labelling of funds.  The Fund EcoMarket (SRI Services)  SRI Styles have done this for 9 years. We look at labelling through the eyes of an intermediary who has the task of explaining funds to their clients (and so focus on highlighting core similarities and differences).  This method focuses largely on the ‘issues’ funds consider – but it does not end there.  The approach a funds takes is also crucial. Taking ‘sustainability’ as an example – funds may take a lighter touch, approach whereby they aim to avoid the most significant ESG risks by excluding companies with poor environmental, social and governance policies, practices (or reputations), or a themed approach whereby they focus on companies that look set to prosper because they are ahead of the curve on environmental and social issues … or they may focus on generating positive impacts perhaps selecting only ‘pure play’ companies that are driving change.  Or they may blend all three.  Knowing this  is often important to clients – so labels are a useful starting point, not a panacea.  (This 6 minute video  helps explain some of the terminology used by funds  in this area.). We can expect to see more on this from the IA, the EU and others over the coming years as there are important labelling and sustainable finance taxonomy projects that are ‘work in progress’.
  11. Marketing funds and products in this area is not easy.  More experienced fund (and portfolio) managers know to offer layered information (core details, with supporting information as backup)  and use caveats and de minimis limits to allow for the fact the fact that in real life companies change over time (sometimes rapidly – when they make an acquisitions or sell a subsidiary).  Yet these can put people off.  Some think these are indicators of ‘greenwash’ – and it is possible that in some cases they might be.  But in general I see these as recognition of the complexity of investing in often quite  large companies – and a desire to ensure clients are not misled. In brief: caveats & detail good – binary language bad.
  12. However… some funds do, in my view, overstate their positions.  There are funds that call themselves ‘ethical’ which are minimally different from any other fund.  Some only exclude tobacco – for example.   Some over-egg their stewardship and engagement activity or (inappropriately) use language that is far bolder than their comparable (and sometimes more active) competitors .  Many also fail to follow through with their all important voting strategies.  For clarity – Fund EcoMarket lists all funds that say they have an ethical, social or environmental approach or strategy irrespective of how ‘good’ they are or where they are on their ‘journey’.  There are many reasons for this – including because opinions/needs vary, but also because we do our best to be ‘whole of market’ so that independent intermediaries are presented with a complete list of potentially relevant fund options.
  13. There is some (understandable) concern amongst investors that research from ESG data providers is uncorrelated. There are many reasons for this – it may be that data is  simply imperfect – but equally likely is that data providers are looking at different things.  There are thousands of potential data points for each investee company – each of which will combine both quantitative data and qualitative analysis (‘art and science’).   Users of ESG data should make sure they understand what their research providers covers (and does not cover) and how they operate – in order to ensure they do not misrepresent or over state their analysis.   In brief my view is that data is needed, but the area is complex and dynamic – so blindly using data alone carries risks.
  14. Who likes governments?  A common  area of controversy – highlighted  in the recent SCM report – is government bonds.   The pros and cons of investing in these assets has been debated for decades and will no doubt run for many more.  The fact remains that opinion is split.  Some people will be happy investing in gilts (because governments fund schools, hospitals etc) whereas others will not (because they go to war – or take other actions they disapprove of – Gina Miller’s views are in the public domain).  The answer again is transparency.  Listing fund holdings if always a good idea – but is not necessarily of much use to individual investors – so the first line of defence should always be to have clear policies and criteria that set out where the fund can and can not invest.  It is also useful to remember that as with the cash elements of ethical portfolios, being able to find appropriate alternative investments to gilts can be challenging,  so pragmatic compromises can make sense, depending on your views (eg  UK gilts ok – bonds issued by countries with poor human rights records not ok.)

To summarise – ‘the greenwash challenge’ has many faces.   Sometimes what may appear to be greenwash is simply a ‘different strategy or approach’,  sometimes fund managers and marketing departments can get a little carried away – and occasionally people just get things wrong.  Although not to be ignored, these can generally be dealt with through improved processes and better information flows.

The aspects I’d suggest focusing on – if you are minded to do so – are poor/lazy/opportunistic product design and benchmarking, funds/fund companies (or anyone else) that baffle potential clients with wafer thin or incomplete information (on data, stewardship, fund policies and practices etc) – and what may or may not be intentionally overblown claims.

In defence of the investment community I’d suggest deliberately doing things badly is probably pretty rare – although there is clearly room for improvement.  Not ‘intentionally misleading people’ is a million miles from making sure clients make have investments that are right for them…  so much remains to be done, particularly by intermediaries.

As such I entirely agree with SCM’s call for improved transparency, if not necessarily all other aspects of their analysis.

If I had a wish I’d turn back the clock and tell my younger self to make a lot more noise about the need to match funds to client personal opinions,  to shout about climate change a lot more – and not to take ‘no’ for an answer. I was involved in doing research two decades ago that indicated clients were far more interested in this area than their advisers thought they were. And with my UKSIF hat on I was also involved in lobbying the then FSA for fact finding improvements…

Given that I can’t turn back time I will have to settle for asking everyone who agrees investment can and should be a force for good to act with speed.  Rule makers must not rush – but fund managers, intermediaries and advisers can improve what they do overnight – if they so desire.