Four ways to check under the bonnet of ESG funds

It's down to investors to research what they consider to be greenwashing

Greenwashing is one of those terms that makes a lot more sense when discussing consumer goods than investment strategies.

I recently saw a soft drinks company claim ‘water neutrality’ (making drinks commercially uses staggering quantities of water) but the small print showed it excluded most of the water used when manufacturing the drinks. This is a dishonest attempt to hoodwink a customer into buying a product. There isn’t really much nuance involved in defining water usage. You make a product and use a quantity of water to do it. It’s quantifiable. 

This is not the same in investing. Making a piece of software uses less resources than making an electric car, but only one of these products will decarbonise transport. Both products are inherently more environmentally benign than drilling for oil. We should drill less oil and do more renewables.

If we could get more oil companies to do this, it would probably have a bigger impact than making a new version of the computer game Angry Birds. But the only way to get an oil company to do this is to invest in one, so you have a vote and are able to influence that company.

What greenwashing has become in investing is a catch-all insult used to discredit the integrity of a strategy based on someone’s subjective judgement of what is and isn’t ‘good’. We probably need to move away from this and focus on the three ways a fund might conceivably be ‘green’:

  1. Buying businesses doing stuff that don’t use a lot of carbon, such as tech and healthcare 
  2. Buying businesses involved in decarbonising a sector, e.g. electric cars
  3. Buying a carbon intensive business then attempting to ‘change’ them, or at least start to have an influence over the way they operate.

All are valid. Funds just need to be explicit about what they are trying to do and generally they are.

Do your homework

That said, greenwashing in ESG does exist, although probably to a lesser extent than some of the headlines would have you believe, and it’s down to investors to do the research to work out what they consider to be greenwashing.

See also: – Best and worst funds for SDG progress

So, as investors, what should we all be looking out for? Here are a few ideas:

The ‘highest ESG-rated companies in each sector’ might be smoke and mirrors.

A few years back, eight out of 10 of the biggest so-called ‘sustainable’ funds in the US were found to be invested in oil companies.

Their fund managers explained they designed their funds to offer investors a similar level of risk and return to those they’d expect from a broader market index. And to achieve this, they need exposure to a range of sectors including ones such as fossil fuels. If they excluded the entire oil sector because it’s bad for the environment, they will not own the same stocks as the market and their fund might underperform when oil companies do well, such as we’ve seen this year.

The grading of these companies and funds is on a spectrum and if there is a sector, like mining or gas, that isn’t particularly environmentally conscious, they invest in companies that aren’t such bad offenders (for example, an oil company that does a bit less fracking than another company).

Some believe it is better to engage with the oil majors and try and change things from within. But investors need to be clear on this point if they have certain principles with regards to ESG investing.

So with funds like this, their goal is not to pick environmentally conscious companies, but use ‘ESG’ in the name of the fund to appeal to those investors with a conscience.

Find the fund’s voting policies.

A lot of funds will purport to be ESG funds but won’t use their voting rights for ESG purposes. Take BlackRock – it is very clear on its environmental principles and what it expects of its portfolio companies, but a few years ago, ShareAction, a shareholder action group, found that BlackRock supported less than 10% of climate-related shareholder resolutions. The world’s biggest asset manager tended to work directly with investee companies through its own internal stewardship teams rather than use its voting power to affect change.

BlackRock now uses its voting rights as it has become the defining ESG voice in the asset management industry. It has taken a lot of political flak for this – in the US, the Republicans aren’t happy at what they see as BlackRock’s hardened leftist stance in support of ESG policies and governance. But the point for ESG investors is it’s worth taking the time to see what ESG funds do in terms of influencing positive sustainable change at their portfolio companies.

Challenge fund manager policies.

If an asset manager is claiming theirs is an ESG fund and that they encourage their businesses to be progressive, then you are within your rights to challenge them on that and ask them how they do it. How do they engage with companies about their water usage for example? Or what’s their policy for speaking to directors about strategies to minimise waste in the operations or production process? These policies should be documented and if there is a lack of transparency, you need to be asking why that is.

Check the fund’s own environmental record.

In a situation where it pays to practice what you preach, it’s important the fund has a good an environmental track record, particularly if it is trying to effect change within its portfolio companies. What policies does it have around electricity usage and corporate travel? If fund managers are flying around the world unnecessarily, or organising big corporate junkets for worldwide attendees, then this isn’t the best message when you are trying to influence good ESG behaviour.

Of course, there are lots of other red flags to help make sure your ESG investment is a credible one. But investors have to do the groundwork to ensure the fund they want to invest in reflects their individual principles and what ESG means to them. As with everything investment related, do your homework and have a good look under the bonnet.