Leading voices from across the industry discuss the real threat of greenwashing

A one-hour watch.

Responsible investing, or ESG to some, is clearly top of the agenda for portfolio construction today. As we’ve discussed across Octo, asset managers are embracing this topic with much enthusiasm, though with every new ESG fund launch comes more cynicism and, ultimately, some accusations of greenwashing.

We decided to tackle this topic head on with our latest Hot Topic virtual lunch, attended by representatives from across the board from fund pickers, a regulatory expert, and a fund manager himself.

Our host, Georgina Mitchell, MSCI, took the bull by the horns asking guests if there really is the risk of an ESG bubble, with too many investors piling into the same stocks, whether that’s renewables, electric transport, or indeed in many cases tech.

Wrongdoing rumbled

“There has been a lot of talk about how ESG funds have outperformed non-ESG funds in the past six or seven months and that is inevitably down to the sectors they are in,” said Mikkel Bates, regulatory manager at FE Fundinfo.

“I think people are getting wise to that now and it’s being seen as another example of greenwashing to start promoting an ESG fund based on recent performance during Covid. The practice has been rumbled”.

Mikkel expects further rotation to other sectors that are becoming more sustainable, and indeed managers and their funds that are adopting more sustainable practices.

He added: “If, say, tech does have a correction then you will see some sustainable funds that won’t be as impacted as others because they won’t be relying on tech now. That is probably when the chicken’s come home to roost if there is a tech correction to see what it does to the ESG sector”.

From a fund manager perspective, Ben Constable-Maxwell, head of sustainable & impact investing at M&G, stressed that valuation analysis should be just as much a central part of an ESG or impact fund as with any other.

A structured process

“You can’t say ‘we’re just going to invest in this nice green theme or good ESG companies’; that would be a very short-lived approach and I think it would bring the whole of this ESG, sustainability and impact movement into massive disrepute and it would fail,” he remarked.

“Any ESG manager worth their salt needs to have a very thorough, structured investment process to identify good businesses, and ultimately good investments with valuation analysis at its core”.

Ben singled out some stocks in areas such as clean tech and electric vehicles, where he believes valuations have been “disrupted or dislocated from the reality of the business model and its likely long-term returns”.

He concluded: “I would say it is not a bubble, and you can find great businesses at still attractive valuations and when and if certain areas of the market do potentially hit bubble territory it’s the job of the fund managers to make sure they understand the businesses that are overvalued.”

Questions you must ask

So, what can professional fund pickers do to ensure the managers they choose are not simply greenwashing, with strategies based more upon marketing than actual substance?

“The first question is to really understand what that ethical or ESG fund is doing, because there are lots of funds out there all doing something slightly different,” said Paris Jordan, head of consulting at Murano, and founder of ethical investor network Virtuvest.

“What does the client want? Do they want exclusionary portfolios? Do they want a positive impact? Or do they want to make a difference in terms of engagement?

“Also, I’d mention what I always call my litmus test – if you remove that ethical or ESG process that the manager has adopted within their fund, how does it change the outcome? If it doesn’t change the outcome if they remove their screen or their ESG risk management, then you know they are probably greenwashing.

“If you do remove it and the portfolio changes quite a bit, with say some oil majors in there or if certain sectors are now included or not included, that’s when you can tell they are doing something and they are serious about it.”