Being ‘green’ is simple but not easy.
An outstanding investment phenomenon of this decade is the sky-rocketing popularity of investment funds that embed environmental, social and governance principles.
Its speed and scale have, in turn, exposed a major faultline: there is no widely accepted definition of what constitutes ‘good’ corporate behaviours consistent with the principles.
The available definitions are invariably based on value judgement. As a result, data providers adopt diverse criteria to such an extent that it has conspired against a standardised reporting framework.
Such ambiguity has played into the hands of asset managers seeking to burnish their ESG credentials by ‘greenwashing’: respraying the old products ‘green’.
Under the resulting regulatory crackdown, such funds have lost market share in Europe lately, according to data from the Global Sustainable Investment Alliance, an advocacy group. The share has declined from 53% in 2016 to 49% in 2019.
The burden of proof is shifting: end-investors are becoming aware that product labels can be misleading. Talking the talk is one thing; walking the walk quite another. Their asset managers are being forced to address many difficult issues hitherto pushed under the carpet.
First, what criteria should their portfolio managers use if a company is strong on governance and less so on society and environment? What weights should be accorded to these disparate individual components?
Second, should a company be avoided if it has any revenue derived from, say, defence or fossil fuels? In these and other examples on the exclusion list, what threshold is high enough before a company is deemed ‘bad’? What if the company has other activities that are viewed as beneficial from its exemplary practices on, for example, workforce diversity and community involvement?
In this context, the EU’s latest action plan goes a long way towards creating what it calls ‘sustainable taxonomy’ that offers guidance on what constitutes ESG-friendly activities and how to seek out reliable data.
Just as importantly, a consensus is emerging that ESG investing should not solely focus on ethical screening. It should also fast forward the transition towards meeting the UN’s 17 Sustainable Development Goals by promoting the required innovations.
The purist approach that characterised ESG investing in the last decade via sifting out ‘sin’ stocks is being augmented by hard-nosed pragmatism. This, in the belief that ESG investing is an inexact science. And will always remain so. As investors and their managers progress up the learning curve, greenwashing can be minimised, but not eliminated.
For more details, please see my piece on the subject in today’s FTfm (9th September 2019).