Avoiding investments that are green in name only

The growing appeal of ESG investing leaves financial advisers shouldering a new level of due diligence.

One downside of the fast-growing appeal of sustainable investing is that companies and asset managers are sometimes taking shortcuts to becoming “green enough” to appeal to investors.

The process, generally described as greenwashing, can be as subtle as adding an ESG label on a fund or as overt as making false claims about how much a company is committed to environmental, social and governance causes.

For financial advisers trying to find the most appropriate ESG investment products and strategies for clients, this means another level of due diligence.

“It’s important to assess how serious companies are when it comes to their ESG efforts,” said Lori Keith, portfolio manager at Parnassus Investments.

Greenwashing is becoming more common, Keith explained, “because companies are seeing the benefits of being viewed in a positive light” regarding popular sustainable causes.

In a panel discussion this week at the Women in Asset Management virtual conference, Keith said the problem of greenwashing is at least partially attributable to the lack of standards around ESG and sustainable investing.

“The industry is still evolving and a lack of [sustainable investing] standards makes it difficult for an investor to ascertain how serious an asset manager is about ESG,” she said.

The greenwashing problem is found at both the individual company level and at the asset manager level. But while financial advisers are responsible for vetting the funds for greenwashing offenses, those same advisers are expecting the portfolio managers to conduct that due diligence on their underlying portfolio holdings.

“Fund ratings are a good place to start, but that shouldn’t be the be-all and end-all of your research,” said Anita Baldwin, head of research and sustainable investing at Hartford Funds.

Beyond the ESG ratings from organizations like MSCI and Morningstar that provide a snapshot of how funds are managed, Baldwin said advisers should look at how a fund company prioritizes ESG investing at the firm level.

“If they have a team of analysts dedicated to ESG issues, it’s important to know where that team sits in the organization, because you want to determine how important they are,” she said. “You can find out a lot when you ask an investment team these kinds of questions, and it says a lot if they can’t come up with an answer.”

Keith said screening for greenwashing also includes looking carefully at the prospectus.

“Look at their top 10 holdings and see if those companies are really reflective of what they’re advocating,” she said. “Also look at proxy voting to determine if they’re willing to take a stand and in some cases, vote against management.”

At the portfolio manager level, Keith said the quality of the research is “absolutely paramount” when trying to determine whether an individual company is trying to greenwash its commitment to ESG.

“We don’t just talk to investor relations, we talk to management and we visit plants,” she said.