Greensheen and the $40 trillion trade
As sustainable investments surge, the ESG message is being lost in a marketing rush for assets, creating new challenges for investment advisers
By Anthony B. Davidow
(About the author: Tony Davidow is president and founder of T. Davidow Consulting, an independent advisory firm focused on the challenges facing the financial services industry. His focus is on helping advisers and investors incorporate complex strategies in their portfolios.)
WILTON, CONN. (Callaway Climate Insights) — With the incredible growth of sustainable investing options, many asset managers are evaluating launching new strategies and/or repositioning existing strategies. Greenwashing (also called “green sheen”) is becoming more of a concern where raising money is the primary motivation.
Investopedia defines it thusly:
“Greenwashing is the process of conveying a false impression or providing misleading information about how a company's products are more environmentally sound. Greenwashing is considered an unsubstantiated claim to deceive consumers into believing that a company's products are environmentally friendly.”
Greenwashing can be categorized into several types.
Environmental imageries: Using images of leaves, animals, and green packaging are all forms of greenwashing.
Misleading labels: Certain products are labeled “certified” or “100% organic” without any supportive information to prove the claim.
Hidden trade-offs: Companies can put up a front of being environmentally friendly and sustainable but may have unfriendly trade-offs. For example, a company may use “natural” or recycled materials, but the goods are manufactured using abusive practices, such as child labor.
Irrelevant claims: You might come across labels that say they are free of certain chemicals, when in fact those chemicals are banned by law.
Lesser of two evils: This is a common practice where a company’s claim may be true, but introduces a greater health or environmental risk (i.e., organic cigarettes).
For asset managers, greenwashing can take the form of claiming to incorporate sustainable screening but not following acceptable guidelines; or making misleading claims about tenure and experience of the investment team.
There are firms with well-established teams and disciplines dedicated to sustainable investing and, unfortunately, those that are greenwashing to gain market share.
According to Pensions & Investments, there are now $40.5 trillion in sustainable assets, almost double the level of four years ago. These strategies are now available to institutions, large families and retail investors, and they are now offered in separately managed accounts, mutual funds and exchange-traded funds. The research showed that roughly 75% of the assets are actively managed, but a growing trend has been the introduction of more passive options, with 60% of new asset flows 2019.
As I have covered in past columns, not all strategies are created equally, with large divergences from one to the next. There are differences in the screening and weighting methodologies, and the universes of underlying securities. There are differences in the definitions used and sources of data. These differences can lead to dramatically divergent results over time.
Similar to consumer products, there should be truth in labeling in all sustainable investment products. Firms should be transparent about how they evaluate ESG factors, and how they use them to build portfolios.
With new strategies coming to the marketplace, investors should question them to determine whether the process truly incorporates ESG screening. They should review the company culture and practices. Investors should review the tenure and track record of the investment team; and should review the underlying portfolio holdings.
For public companies, it may be helpful to review their underlying ESG scores. Does the company incorporate sound environmental, social and governance practices? Are they focused on reducing their carbon footprint? Do they have diverse leadership and boards? What are the company demographics? Are their sufficient checks and balances?
Advisers can serve a critical role in educating investors and vetting strategies. They can help determine the firms and strategies that have committed to sustainable investing, and those that are using some form of greenwashing to capture assets.