‘Greenwashing’ potential tarnishes growth

With sustainable investment funds accounting for as much as 1 in 4 institutional dollars under management, it raises the question of how much is real progress vs. mere marketing.

The growth has been nothing short of astounding. Assets managed under ESG principles reached $14.6 trillion in 2019, a 168.1% increase from $5.4 trillion in 2016, when Pensions & Investments began collecting the data, and up 27.3% from the end of 2018. The question is, how much of that growth is truly new?

As much as 86% of the $1.2 trillion in sustainable mutual funds and ETFs added in 2019 came from rebranding of fund names, according to an analysis by Michael Cosack, a principal with sustainable investing consultant ImpactWise LLC, and Henry Shilling, director of research for Sustainable Research and Analysis LLC, both in New York.

"It's clear that there is lots of product coming into the marketplace. There are now over 1,000 funds pursuing one form of sustainable investment strategies, and that in our view has contributed to a lot of confusion. We are not suggesting that greenwashing is taking place, but this could lead to disappointment and could lead to greenwashing," Mr. Cosack said.

Greenwashing is the practice of making unsubstantiated or misleading claims about a product or strategy's environmental, social or governance benefit.

"There can't just be a name change. It should be coupled with a classification scheme. The industry is in the best position (to do that), but if the industry fails to come together then it's going to have be punted over to the regulators," Mr. Cosack said.

Cheryl Smith, managing partner and portfolio manager with Trillium Asset Management in Boston, a firm with $2.8 billion in assets under management that incorporates ESG data into its evaluation of companies and investment strategies, said as "more and more competitors" claim to sponsor ESG funds, there are various ways to approach concerns about greenwashing.

"Are you screening, are you integrating, are you engaging companies through proxy voting or shareholder advocacy? We certainly welcome money managers paying careful attention to the proxies they are voting on. Then there's the question of how engaged are you? Is a money manager actually crafting an ESG policy or accepting an advisory firm template? We think it's something people ought to think about," Ms. Smith said.

While proxy voting is "a minimal indicator ... another question is how a company is doing its analysis," she said. Third-party providers such as MSCI ESG Research and Sustainalytics "do a great job of scraping public research, but if you are using only (those firms), you are outsourcing all of the analysis of how different issues are evaluated. You are ceding a large part of the investment process over to the ratings provider," Ms. Smith said.

Investors shouldn't be ceding their role either, said Craig Metrick, chief investment officer for Cornerstone Capital Group in Denver, with $1.2 billion under management targeted for environmental and social impact. "It is up to people to make sure (greenwashing) is addressed," he said. Part of problem can be that "investors don't articulate what they want. Both sides have to be responsible and accountable. If more investors get out there and say what they want, that will push managers," Mr. Metrick said.

In addition to knowing what their clients want, "we are making sure that we don't just kick the tires, we are going under the hood. You really have to look at holdings not just on a specific day but over time and process. Is the manager walking the walk in its own operations? How is it going to look when we do our own reporting to clients?" said Mr. Metrick, who calls the current quality of manager reporting "mixed," but improving, "just like corporate reporting did."

"I think managers are getting the message that at least for certain clients they are going to have try a little harder. Just putting ESG in the name isn't going to cut it anymore. Any investor serious about ESG is going to want to see that there's a process behind it," Mr. Metrick said.

Regulators are also starting to watch out for greenwashing, said Matt Christensen, global head of responsible investment for AXA Investment Managers in Paris, whose $569 billion in ESG-integrated funds in 2019 represented 85% of their open funds. "I am concerned about it and regulators are concerned about it," especially European regulators that are already requiring or preparing to ask for more disclosure, Mr. Christensen said. AXA IM built its funds with that level of disclosure, he said, "because we just think there is going to be more and more regulation."

Remy Briand, head of ESG at MSCI Inc. in Geneva, sees two dimensions to greenwashing: the products built by managers that "may or may not be" what they represent, and "the asset managers or the pension funds that will be greenwashed by the companies. Resolving those two issues really require two approaches," he said.

For products, describing the strategy "is not enough," said Mr. Briand, who has seen more of an effort by managers to describe the outcomes. Asset owners and managers "need to look for evidence and there, you need alternative sources of data. In our view, that should be the common aim for people claiming to be doing ESG ratings, but right now we are in the space where anyone can show up and claim it." Once the industry comes up with best practices, "it will get the clarity that is needed," he said.

In March, the SEC sought public comment on updating its "Names Rule" against misleading fund names, and asked whether there should be specific requirements on when a fund can be characterized as ESG or sustainable.

Some of that will come from performance metrics, said Dave Goodsell, executive director of the Natixis Center for Investor Insight in Boston. "We are definitely seeing more inquiries about how to measure performance. On the other side, it is going to be (about) intentionality. Folks want to make sure that (managers) are fulfilling that part of the equation as well as performance. I think the world is moving along to answer those questions," Mr. Goodsell said.

Consultants can also play a critical role in detecting greenwashing or rebranding. "I am confident that in the vast majority of cases that we can see through that stuff," said Adam Gillett, head of sustainable investments for Willis Towers Watson PLC in London. "When we do due diligence on a strategy, I think we are able to pick that up."

Mr. Gillett agrees that asset owners have an obligation to be "absolutely clear about what they are looking for and not looking for."

John Hoeppner, head of U.S. stewardship and sustainable investments at Legal & General Investment Management America in Chicago, sees greenwashing as "a bit of a catchall. It's just general dissatisfaction," said Mr. Hoeppner, whose parent firm Legal & General Investment Management (Holdings) Ltd. reported $199.3 billion of its $1.58 trillion assets managed under ESG principles, according to P&I data.

One type of greenwashing is simple misselling, but "all new markets have definitional problems. And it will get solved," Mr. Hoeppner said. A bigger problem is the number of investments involved in a particular fund, for example, that might be tilted toward climate but could still have energy exposure. "We understand climate risk or ESG analytics, and that helps us outperform the market. One type of greenwashing is classic active management (claiming to outperform indexes). It's just the showmanship that happens across the industry," Mr. Hoeppner said. True ESG performance "is very, very complex to assess. Every asset manager can design a set of metrics to make them look like leaders. The biggest issue is how consistent are they" in actions like proxy voting, he said.

His firm's approach is to disclose conflicts of interest and specific actions such as escalating engagement or asset allocation changes and being transparent about them. "Sometimes it boils down to these very benign metrics," said Mr. Hoeppner, who sees more "watchdogs" coming onto the scene to help assess all asset managers on an apples-to-apples basis.

He and others predict that reporting standards under development by the Sustainability Accounting Standards Board will help set minimum ESG standards for the industry. Investors are also helping, asking for markers such as scores from the United Nations-supported Principles for Responsible Investment in their RFPs. "There is definitely that signaling effect," Mr. Hoeppner said.

"The market has recognized that it is a huge commercial opportunity. Asset managers for a long time had a crisis of purpose. ESG came along and it was this obvious link that had been lost," said Mr. Hoeppner, who is not overly concerned about greenwashing. "The details are what matter. Just make sure you understand them."