Increased interest in responsible investing has led to many investment products being labelled responsible, sustainable, ESG and/or impact. But how can investors be sure their investments are truly responsible? Understanding the concept of greenwashing, and knowing how to avoid it, is key to answering this question.

Conceptually, greenwashing is an attempt by corporations to deceive the public into believing their environmental, social and governance (ESG) products, processes and policies are sound. The concept has been around since the 1960’s, when the nuclear power industry, anxious to remain competitive during the anti-nuclear movement, positioned its power source as a cleaner, safer energy alternative. But the term was actually coined in 1986, in response to hotels that encouraged customers to reuse towels without meaningful environmental initiatives.¹

As consumers and investors continue to express an appetite for more responsible products, companies have been searching for ways to attract the green consumer, as well as the wave of ESG investment inflows into stocks and corporate bonds.

A 2015 Nielson consumer poll found that 66% of people were willing to pay more for eco-friendly products and 50% of purchasing decisions are influenced by sustainability features.²   Meanwhile, $35.3 trillion worth of assets under management are invested sustainably across the U.S., Europe, Japan, Canada, Australia and New Zealand as of January 2020, a 15% increase in just two years.³   The pace of responsible investing growth has surged in the wake of the pandemic, with assets in sustainable funds having grown to $304 billion in the U.S. by the end of June 2021, nearly double the $159 billion record set the year before.⁴

Lack of standardization

With such a rapid growth of assets under management in responsible investments, it’s easy to see how some investment managers may rush product launches and increase ESG marketing, even if they lack responsible investment expertise.

Unfortunately, this has occurred at a time when there’s no consensus on the terminology used for different responsible investing strategies. The industry is not aligned on what corporations should be disclosing and there are differing opinions on what criteria should be used to assign ESG performance scores on publicly listed companies. Together the fight for market share in responsible investment products and the lack of standardization have set the stage for greenwashed investment solutions.

In April 2021, the SEC announced that it found instances of potentially misleading statements regarding ESG investing processes, and representations regarding the adherence to global ESG frameworks, which likely led to their prioritization of scrutinizing ESG processes in 2021 exams.⁵

This underscores the importance of both investors and investment managers to articulate their objectives clearly, and ensure their interests are aligned. A strong due diligence framework can help investors avoid greenwashing while the adoption of industry standards and frameworks can reduce its occurrence.

Over the years, industry bodies have been formed to develop standards and frameworks around responsible investment. Recently, some of these groups have joined forces to enable greater reach and better consensus on the topic.

Most notably, the International Integrated Reporting Council (IIRC) and Suitability Accounting Standards Board (SASB) merged in June 2021 to create an integrated reporting framework with accounting standards. The goal is to support businesses and investors, by developing a shared understanding of enterprise value and how it’s created and preserved (or eroded) over time.⁶ Additionally, the CFA Institute is developing global industry standards to establish disclosure requirements for investment products with ESG-related features. Another recent development was the launch of the U.S. Investment Consultants Sustainability Working Group (ICSWG-US) in May 2021.  ICSWG-US is a collaborative effort of investment consulting firms, intended as a resource on activities such as the standardization of ESG integration.

Align objectives

The development and adoption of standards and frameworks are critical steps toward reducing greenwashing. But the onus remains on the investor and their advisors to understand what they are investing in.

Identifying greenwashed investment solutions requires an understanding of the underlying investment managers’ commitment to responsible investment, as well as their approach and objectives. The manager must be able to explain how the strategy works to achieve its responsible investment goals.

For example, negative screening may be appropriate to ensure a portfolio does not invest in companies whose products or services conflict with an investor’s personal values – and it’s relatively easy for a manager to illustrate their portfolio has no exposure to specific issue areas. Yet, it’s more difficult for a manager to illustrate the positive effects on long-term risk-adjusted performance by analyzing corporate ESG metrics to identify material ESG risks and opportunities. A strong investment due diligence framework is crucial to understanding these nuances.

How to navigate

In a market where ESG products are proliferating, investor scrutiny is essential to differentiating between products that do the bare minimum to technically achieve their ESG labels, and those that truly analyze and integrate ESG elements into the investment approach. For example, if a manager states that they integrate ESG for risk mitigation and/or return enhancement, they should be able to describe their research process and the resources used to identify the material risks and opportunities, as well as articulate how the research affects their investment decisions. In addition, a manager that is an active owner and casts proxy votes should be able to illustrate how its proxy policies and voting records align with the responsible investing principals of the strategy or firm.

The Manager Research team at BNY Mellon leverages a due diligence framework with specific, dedicated responsible investing factors. These six factors allow for thorough examination of investment manager commitment, philosophy, process and implementation of responsible investment approach.

Generally, we find that managers who have sustainable fund mandates support ESG related proposals. Based on an internal analysis of Morningstar’s U.S. large cap mutual funds proxy data, sustainable funds appear to support ESG related proposals more often, but support across all funds has increased from 2018 to 2020. Early evidence suggests support for ESG related proposals has further increased in 2021, likely driven by consumer and investor demand for more responsible products.⁷