By 2025, as much as 57%, or $8.9 trillion, of mutual fund assets in Europe will be held in funds that consider environmental, social and governance (ESG) factors. This is a massive jump from the 15.1% held at the end of last year, according to a report published by consultancy PwC last week.
But things are not always as green as they seem, and greenwashing – the practice of only paying lip service to ESG factors with token gestures – is also on the rise.
“From an investor perspective, one of the easiest ways to spot greenwashing is when a company won’t talk about the negatives involved in aspects of their business, only the positives,” said Andrew Parry, head of sustainable investment at Newton Investment Management.
Most investors in Asia apply internally developed compliance processes to identify the right investments, and some of them also rely on third-party-consistent ESG data, said Rick Chau, head of Asia Pacific for index and analytics at Qontigo, a financial intelligence provider based in Germany
“There is a vast amount of data available in the market, especially related to ESG, since institutional investors are becoming more willing to look for data to support their investment decisions,” he added.
Companies’ financial data and industry benchmarking form the basis of data analysis, Chau said. Artificial intelligence is also increasingly being used to capture the vast amounts of structured and unstructured data.
AsianInvestor asked investment experts about the best ways to spot greenwashing and how allocators can achieve better sustainable investment returns.
The following contributions have been edited for clarity and brevity.
Mark Hedges, chief investment officer
Nationwide Pension Fund (UK)
[Greenwashing presents] a big challenge – [for instance,] how do you really get transparency on the underlying assets? That’s why it’s critical to pick the right index for public equities, which is the obvious starting point for ESG investing.
[But] investors also have to be very careful when they look at green bonds. For instance, there are a lot out there, but often it seems that the issuer was taking that approach or seeking that financing anyway, so it’s not doing anything new. It just wants to badge it as green to get a lower cost of funds.
That’s an area we have to think about. It’s harder to focus on ESG in the credit space [than in equities]. How our emerging market debt manager looks at ESG is going to be a challenge for us, I suspect.
It's an issue in developed markets too. We turned one US private credit fund down because one of the loans was to an online gun sales business, and we felt we couldn’t take that kind of reputational risk. The manager was very good; we liked the fund's underwriting and everything else, but we felt uncomfortable with the assets related to gun sales.
Jake Walko, director of ESG investing and global investment stewardship
Thornburg Investment Management
Investors should expect to have in-depth conversations with portfolio managers, who should be able to articulate how ESG considerations influence their investment decisions about sizing, holding periods and stewardship plans.
Fund managers need to demonstrate to their clients a big picture approach to ESG, meaning that they don't oversimplify the issue by simply cutting [out of their portfolios] companies lagging in this area. Instead, they need to identify and discuss which businesses will be winners in the long term, in spite of any perceived near-term challenges.
Ultimately, tackling greenwashing in funds boils down to two parts: trusting the sophistication of a fund manager’s research and whether that sophistication extends to the ESG space.
Edris Boey, ESG practice lead
Maitri Asset Management
First, investors must acquaint themselves with the range of ESG investing approaches such as differentiating between sustainable investing and impact investing. Investors should also consider best practice tools such as screening and ESG integration methods in formulating a benchmark. Finally, it is crucial that investors evaluate the ESG performance of companies by considering the material ESG issues by sector. Investors can leverage a three-pronged approach to establish their own benchmarks and to ensure that they are making robust investment decisions.
For instance, while occupational safety is a critically material ESG issue to a heavy industry manufacturer, it is less relevant to an e-commerce retail company, which would instead prioritise customer data privacy.
Steve Freedman, head of sustainability and research for thematic equities
Pictet Asset Management
One important aspect in distinguishing between high-quality ESG solutions and laggards is the resources that back them.
Investors should consider the extent to which proprietary frameworks have been developed as opposed to relying on off-the-shelf commercial ESG ratings. More advanced approaches will often leverage insights from environmental and social sciences to incorporate ESG aspects into the investment process.
It is also important to take into account how many dedicated investment professionals with ESG credentials support a particular strategy. Investors will also want to consider the quality of the sustainability or impact reporting provided for an ESG portfolio, which is critical to provide the required accountability regarding the integrity of the approach.
Finally, a key feature of ESG investing is active ownership – that is to say, proxy voting and targeted dialogue with the company's management on ESG issues.
Masja Zandbergen, head of ESG integration
Investors need to ask themselves key questions in avoiding greenwashing, including whether the investment manager subscribes to integrated thinking and is engaged with portfolio companies to drive change related to sustainability, whether the manager credibly applies sustainable principles in its own business, and the true meaning of socially responsible investing labels applied to a fund.
There are clearly areas that investors want to avoid, such as tobacco, weapons, breaches of labour standards and human rights, as well as certain types of fossil fuels like thermal coal. But there are many other areas that aren’t as clear cut. In addition, a strategy is only sustainable if it is also financially sustainable. Integrated thinking is important.
How do long-term ESG trends and external costs such as climate change, loss of biodiversity and rising inequality lead to changes in business models? ESG investing no longer means only reducing an investment universe to the best-scoring names. It means thinking hard about sustainability and how it affects companies and investment strategies.
Mervyn Tang, global head of ESG research
ESG investing is an umbrella term for a wide range of investment approaches – some focused on managing the societal impact of their assets, some on improving risk-adjusted return by taking better consideration of sustainability issues, and others may be trying to achieve both. A starting point for investors to understand an ESG product is to clarify the objectives.
But even ESG funds with similar objectives may have very different approaches. For example, one manager may look to identify ESG leaders that are performing strongest on sustainability metrics and have the most coherent sustainability strategies. Another may try to identify ESG laggards that have the best prospects to improve under the same metrics. Both are considering sustainability in their investment approach, but the composition of the portfolios will not look alike. Sustainability labels alone may not be sufficient to identify the nuances of a fund’s ESG strategy. Investors will need to do their homework.
The complexity for investors is likely to be compounded, as innovation expands the range of ESG products available, such as to include sustainability-linked bonds. Regulation will play some role in standardising labels but may not keep pace with the rapidly evolving industry.
Marion O’Donnell, associate director for sustainable investing
Investors are increasingly seeing the term "sustainability" being used as a buzzword. There is a concern, however, that this is being embraced only at a superficial level by Asian companies. Investors need to be confident that they are investing in companies that are genuinely embedding sustainability as part of their long-term strategy, rather than those that just say they are.
As sustainable investing increases in focus, it will take time for companies to come to agreement on reporting standards for ESG factors and providing comparable data. Greenwashing is a concern, but it is a natural bump in the road to transitioning to a sustainable global economy.
To gain confidence in a company’s sustainability performance, investors must do their due diligence on the company, its peers and industry standards. Investors should also develop their own sustainability ratings across investment coverage that provides a forward-looking evaluation of a company’s trajectory on ESG-related issues.
In addition, companies are becoming increasingly transparent on sustainability matters and regularly engaging their stakeholders to get a view from them of the material ESG factors that need to be addressed in their corporate reporting.
Joe Marsh contributed to this article.