Over the course of the last five years, the ESG investing landscape has blossomed. Now more than ever before, investors are putting their money toward making our world a better place. According to a recent article from Bloomberg, ESG assets are expected to reach $41trn by the end of this year and hit $50trn by 2025. Furthermore, the Global Sustainable Investment Association estimates ESG-related assets account for one in three dollars managed globally. In a sense, we’re living in an ESG boom.
But it should surprise no one that with the explosion of ESG investment products, a wide array of “greenwashers” have arrived on the scene. Greenwashing is using a marketing spin to mislead or lie to investors about how “green” or sustainable is an underlying investment. At its worst, it’s highly unethical to, say, market a fund as fossil-free when a review of its holdings shows allocations to oil and gas companies.
These funds grab a lot of negative headlines, but also consider that the vast majority of ESG greenwashing comes in the form of products built on a foundation of half-truths coming from the public companies that comprise these portfolios and then packaged into ratings by ESG data aggregation firms, with proprietary (and opaque) scoring algorithms. Investors think they’re investing in good companies, because they are only invested in companies with good ESG scores. Garbage in, garbage out, or put differently, greenwashing on greenwashing on greenwashing.
To me, this is the real problem, because if you think of ESG as a continuum of authenticity, at one end of the spectrum, there are products that are highly authentic, with portfolio managers who are deeply committed to getting it right and getting it right is hard work. At the other end of the spectrum are a handful, maybe more, of products using the ESG movement to gather assets with little regard for the truth. And then there’s the middle: Where most of ESG products reside, most of the clients are invested and all the participants want to believe they’re doing the right thing.
There’s been plenty of press recently on whether ESG data aggregators are misleading investors with proprietary scoring approaches that don’t necessarily align with how investors think about the underlying issues. I’m not jumping on that pile except to say we’d probably have a lot less incidental greenwashing if the firms providing ratings simply sold raw data rather than final scores, thus forcing investment firms to think about these issues within the construct of whatever ESG framework makes the most sense for their investors.
Case in point: Russia following the invasion of Ukraine.
In The False Promise of ESG, the authors explain how nonfinancial European companies with substantial operations in Russia get higher ESG scores than their counterparts that don’t do business in Russia, even though Russia has little regard for human rights, corporate governance or the environment. Is this the fault of the raters for missing the connection to Russia, or of the investment firms that purchase the ratings for not imposing their own ethical framework on the process?
I suspect the latter. There’s too much complacency when it comes to ESG, driven by the fact that it’s much easier to simply accept a score and move on. And this to me is a far bigger issue than greenwashing.
Several weeks ago, the Securities and Exchange Commission proposed a rule that would force public companies to release climate-related information. This rule will be beneficial to investors as it will standardize the data for easy comparison. Right now, this is missing, so investors must try and separate the truths from the half-truths and the all-out greenwashing.
While burdensome in energy-intensive industry groups, it’s very hard to imagine this making a discernible dent in profits. Surely, it will create additional work, but those companies that have been lobbying against mandatory disclosures are likely most concerned about being viewed as a laggard within their respective industry group to their customers, employees and shareholders.
For example, investors understand that oil and gas companies have high carbon emissions. No one expects them to have the same emissions profile of say, a renewables company. There will be leaders and laggards across the economy, which will put pressure on laggards to be more ambitious in their reduction targets, and that’s the whole point.
In the short run, stakeholders, from investors to employees to consumers, benefit. In the long run, the companies themselves benefit as increased transparency will hasten improvements. We are at the point where I believe this is a function for the SEC. Voluntary disclosures have served a purpose, but will only take us so far, and too slowly.
Bill Davis is managing partner at Stance Capital.