Greenwashing in ESG: Don’t Judge a Book by Its Cover

By Tamara Stein on March 1, 2023

Greenwashing: The act of making false or misleading claims about the environmental benefits of a product, service, technology, etc.[1]

Corporate FInance Institute.

With rising interest in Environmental, Social, Governance (ESG) investing, investment managers have been quick to respond. New strategies have been launched, existing strategies have been updated and marketing materials have been created. However, some investors are rightly asking what is marketing and what is reality? Recent headlines surrounding the departure of some high-profile ESG professionals at large asset managers and the SEC’s renewed interest in helping investors look beyond the fluff has added to these concerns.

To help wade through this debate, Fiducient Advisors (Fiducient), an investment consulting firm, recently took an independent look at ESG integration across asset managers. To help set the stage, the team first defined Integration.

ESG Integration

Fiducient defines ESG Integration as the inclusion of ESG factors into the financial analysis and investment process of money managers. This may entail the inclusion of potential ESG risks and opportunities and their possible effect on estimated future cash flows or balance sheet assets and liabilities. According to the US SIF Trends Report 2020, the most commonly applied approach to ESG investing is now ESG Integration.

Of the money managers responding to the US SIF Trends survey, 74% reported applying ESG Integration into their investment process, affecting just shy of $3.5 trillion of assets under management. Similarly, of the institutional investors responding, 68% reported incorporating ESG Integration into their organization’s portfolios, representing $495 billion of assets.

Fiducient’s findings show a similar trend. According to a 2021 proprietary survey sent to managers of strategies that the group recommended to clients, 86% of respondents as of December 2021 used ESG as a component of an investment’s alpha or risk assessment. The survey findings also showed an increasing trend in ESG Integration, as shown below:

This is good news for investors who wish to incorporate ESG into their portfolio. Historically, investors may have needed to make significant changes to their holdings, vehicle types and/or asset allocation to align their portfolio with ESG principles. With ESG integration being more common, that may no longer be necessary. Investors with ESG interests may be pleasantly surprised to find “non-ESG” strategies have already incorporated some of these factors in their portfolios.

However, the idea that ESG integration is now pervasive and commonplace should be tempered. It is important to note that these trends are self-reported. It is not surprising that as interest grows for ESG investing and more money moves in that direction, the investment management community will respond favorably. This begs the question: With so many investment managers self-reporting ESG Integration, how many are doing so in a meaningful way?

In assessing ESG Integration practices, Fiducient generally asks three primary questions:

1. Is it observable in the investment process?
2. Is it material to the investment process?
3. Is it additive to the investment process?

In other words, through due diligence, can you distinctly observe the incorporation of additive ESG factors within a money manager’s investment process? Applying this framework, the team believes 35% of its recommended public markets strategies meaningfully integrate ESG analysis into the investment process. That differs from the 86% of respondents self-reporting Integration.

There are a a few notable takeaways from this observation:

1. Such a gap is not surprising. ESG in general, and ESG Integration in particular, can be difficult to define and assess. Therefore, it is easy to claim without needing material changes to the investment process to back it up. Additionally, with interest growing from investors, asset managers have an economic incentive to move toward ESG in hopes of attracting new inflows.
2. This further highlights the benefits of conducting deeper research on a strategy rather than simply relying on information provided. This greenwashing effect is likely to persist for some time as the industry comes to terms with common definitions and better sources of data.
3. While well shy of the survey respondents’ rate of 86% percent, many investors would nonetheless be surprised that on average more than a third of their portfolio, which does not have ESG titled investments, may use ESG information as part of the investment process.

One of the more powerful outcomes from this deeper level of analysis is how to help investors interested in ESG investing. If Fiducient’s assessment is correct and less than half of self-proclaimed ESG Integrators incorporate ESG in a meaningful way, many investors may be stuck in platitude purgatory. In other words, investors often with good intention believe they are taking actions to help further their mission, but in reality, are having a limited impact.

We believe by digging through greenwashing, by being pragmatic and exploring additional ways beyond just Integration to further your mission, we can help our clients avoid this common pitfall.

[1] Definition provided by the Corporate Finance Instistute. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/other/greenwashing/ on February 23, 2022.

There is no guarantee that integrating Environmental, social, and governance (ESG) analysis will improve risk-adjusted returns, lower portfolio volatility over any specific time period, or outperform the broader market or other strategies that do not utilize ESG analysis when selecting investments. The consideration of ESG factors may limit investment opportunities available to a portfolio. In addition, ESG data often lacks standardization, consistency and transparency and for certain companies such data may not be available, complete or accurate.