Greenwashing is the new black in the investing market.
What is Greenwashing?
‘Greenwashing’ is the process of using marketing tools to create a false impression of a company or fund being environmentally friendly. This ‘green sheen’ aims to persuade the public that an organization's products, policies, and processes are sustainable; although there is often no tangible data backing these claims.
The concept of greenwashing has recently crept into Environmental, Social & Governance (ESG) funds.
ESG Mutual funds differentiate themselves from other mutual funds as they invest solely in companies meeting high standards of governance and sustainability. These funds have attracted huge inflows in recent times due to their perceived commitment to investing in ‘green’ and ‘ethical’ companies.
Why do Companies & Funds Engage in Greenwashing?
Lying on the precipice of conscious capitalism, ESG funds are particularly vulnerable to being greenwashed. Market regulators are yet to prescribe a standard metric to measure a fund’s performance in terms of sustainability. Hence funds may be tempted to exaggerate eco-friendly claims & actually invest in companies that don’t really have a clean record.
These funds have to perform the tightrope of delivering healthy returns while appealing to ethically driven investor sentiment. Hence, funds may heavily publicize their green focus as an excuse to underperform the market or worse- as a publicity tactic to attract small investors that want to ‘feel good’ about their investing decisions. These investors are unlikely to check whether the fund actually delivers on its green promise.
Companies that fail to engage in green practices face the risk of bad publicity. They are deprived of funding as investors don’t want to be associated with a polluting entity. This quagmire was recently faced by the Adani group who were refused financing & renewal of insurance from several institutions due to large-scale protests against their Australian mining operations.
The advent of conscious consumerism means that businesses also face a risk of losing their market share if environmentally hazardous practices come to light. Hence, investors are wary of dealing with such entities.
As a result, mutual funds and companies are incentivized to slap on a ‘sustainable’ label. But to what extent are these claims true & how can small-time investors avoid being greenwashed?
(Also Read: The Red Flags of Green Investment)
How to Spot Greenwashing in Indian ESG Mutual Funds?
Here’s how to do a quick credibility check before investing in an ESG fund:
Step 1: Checking asset allocation.
An ESG fund should ideally allocate 80-100% of its assets to equity shares that are compliant with the environmental, social & governance framework as formulated by the fund manager. A fund that invests an insignificant amount in ESG-compliant shares is probably using the ESG tag as a marketing gimmick.
Asset allocation can be checked from the ‘Key Information Memorandum’ available on the funds’ website and giving a search under the term ‘asset allocation’.
Step 2: Selection Procedure.
Most funds will not reveal the rationale behind selecting a particular stock citing a confidential selection process. However, funds are bound to briefly disclose their investing rationale.
In such cases, a fund that discloses a quantitative/systematic selection criterion should be preferred over a fund that uses extensive jargon without numerically quantifying the same.
Step 3: Portfolio analysis & red flags for green investing
The group of securities that a mutual fund invests in is called a ‘portfolio’. Funds buy and sell their investments based on market conditions; hence portfolios are dynamic. ESG funds are required to disclose their portfolios at the end of every month.
An easy way to check a fund’s portfolio is to visit https://www.morningstar.in/default.aspx and search for the fund’s name. Under the ‘detailed portfolio (Equity)’ tab, we can see the updated list of companies that the fund has invested in.
The purpose of this portfolio analysis is to identify red flags such as:
Investments in oil and gas.
Investments in companies may face litigation due to unethical practices like tax evasion.
Investment in companies notorious for violating labour codes & exploiting workers in unsafe facilities.
Investments in mining, especially in conflict-prone areas.
Investments in automobile companies that have not established a plan to adapt to Electric Vehicle production.
These warning signals indicate that the fund is only doing lip service to its ESG tag.
Step 4: ESG ratings
To cross-check your portfolio analysis or to avoid portfolio analysis entirely and leave the work to the experts, ESG Ratings are a useful tool.
Rating agencies thoroughly analyze a company to arrive at an ESG score.
The score may range from 0 to 100 (100 being the best) or from CCC to AAA (AAA being the best).
MSCI and Refinitiv are popular rating services that provide free ESG ratings on entering the company’s name in the search box.
If a majority of companies in a fund’s portfolio have a rating below A or a score below 50, then this indicates a lack of commitment towards ESG objectives by the fund.
In conclusion, a fund that does not yield satisfactory results on performing the above-mentioned four steps should best be avoided. With the growing popularity of ESG funds, financial greenwashing is bound to increase. While we wait for regulators to develop more stringent ESG frameworks, basic knowledge of a fund’s activities is a tool to protect small investors. After all, the ability to identify greenwashing is the first and most important step to truly sustainable investing.
(Also Read: Investing Beyond the Concrete Jungle)