By late 2021, investment in ESG funds totalled more than USD 35 trillion US dollars, nearly double what it was in 2014. With public figures and policy makers demanding immediate action to combat climate change, ESG investment is both a necessary and good thing. Yet it is increasingly apparent that not all sustainable investments provide the real-world impact they are touted to have, and in many cases, they are simply a means for companies and funds to flash their shiny ESG credentials.
This disconnect between green commitments and impact is not always the result of poor intentions. Non-standardised ESG regulations and ratings, fuzzy science and major organisations pulling in different directions make the world of sustainable investment challenging to navigate at the best of times. However, the reality is that greenwashing has become so prevalent that many are asking whether ESG investing is just a gimmick. For some financial professionals, ‘ESG’ is almost becoming a swear word – many investors have had enough with greenwashing and are starting to dislike ESG labels.
What is the cause of greenwashing?
In 2019, Schroders surveyed over 25,000 investors worldwide and found that more than 60% wanted funds to consider sustainability factors when making investments. This pressure has continued growing in recent years, and as a result, many fund managers have rushed to squeeze themselves into the ESG bracket.
When an item of clothing comes into fashion and demand for it is high, knock-offs and imitations posing as the real thing will inevitably appear. Greenwashing arises from a similar principle. When investors demand green funds, fund managers try and create these, often in the easiest way they can – by crudely slapping ESG labels onto portfolios that are based on an entirely different underlying strategy.
Just like in the fashion industry, the presence of greenwashing in the financial markets does not devalue or decrease the importance of the real thing – i.e., the funds with ESG at the core of their strategy – but it does make the original much harder to verify. In the world of ESG investing, the consequences are much more dire. Money directed towards so-called ESG funds may not be having the impact that investors think they are. Indeed, how much of the 35 trillion US dollars invested in 2021 is genuinely helping save the planet? According to Emma Howard Boyd, Chair of the Environment Agency, “UK banks and insurers will end up taking on nearly £340 billion worth of climate-related losses by 2050 unless we can successfully curb rising temperatures.” We are facing existential fight against climate change, and ESG investing should be focussed on having a real-world impact, not treated as a marketing gimmick.
Is the SFDR fit for purpose?
In March 2021, the European Commission launched the Sustainable Finance Disclosure Regulation (SFDR), in an attempt “to improve transparency in the market for sustainable products, to prevent greenwashing and to increase transparency around sustainability claims made by financial market participants.” Funds are categorised into Articles 6, 8 and 9, depending on whether they do not integrate sustainability into their strategy, have ESG characteristics or have a sustainable investment objective respectively. The purpose of this regulation was to give investors necessary assurance that their investments align with ESG objectives.
On a surface level, this seems to have been successful. A report from Morningstar claims that the SFDR “spurred product development and innovation in 2021” with almost 200 new Article 8 and 9 (“green”) funds appearing in Q4 2021 alone. However, the study also notes that the rise in green funds is not only the result of new funds being launched, but also the reclassification of existing funds. According to Morningstar, Article 6 funds are being re-purposed as green funds through a range of processes. While some funds overhaul their entire investment objective, others will just clarify how ESG factors impact their strategy or formalise ESG exclusions.
The broad scope of the definitions provided in the SFDR, and therefore the wide range of funds included, is partly why the SFDR has drawn criticism. For example, analytics firm MainStreet Partners published a report stating that 21% of funds categorised under Article 8 would not be considered sustainable. Ironically, despite being introduced to prevent greenwashing, the SFDR has partly assisted fund managers who are looking to put a ‘quick fix’ ESG label on their products.
That said, the SFDR is still a step in the right direction, and if the regulation can be fine-tuned and definitions clarified, Articles 8 and 9 could become a true representation of a fund’s sustainable strategy and pave the way towards more impactful investments.
What is the future of sustainable investment?
In light of recent greenwashing scandals, the legitimacy and impact of sustainable investing has clearly been called into question. With investors becoming more averse to ‘ESG’ as a term, the environmental, social and governance aspects probably need to be separated from one another and distilled. Looking forwards, the ‘E’ in ESG is a huge investment opportunity, as climate change has established itself as the next super cycle and is a major driving force for the markets. Meanwhile, the ‘S’ and ‘G’ are risks that investors need to assess and manage, in the same way they do other risk factors.
A study by Morningstar found that 77% of ESG funds that existed 10 years ago have survived, compared with 46% of traditional funds. This demonstrates the potential for longevity in this area of investing and shows that the appetite from investors is not waning. However, the goal now is to ensure that impact of sustainable investing matches the enthusiasm.
About Maria Lozovik:
Maria Lozovik, Co-Founder and Portfolio Manager at London-based asset manager Marsham Investment Management