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The Red Flags of Green Investment

Updated: Jun 14, 2023

Recognize the red flags of sustainable investing before it's too late.

The Red Flags of Green Investment illustration
Two sides by Tarika Jain

In order to pursue their investment goals in a sustainable manner, investors of all sizes are combining traditional investment approaches with environmental, social, and governance (ESG) insights. Investors and finance professionals across the world have recently started recognising the effect the climate crisis is having on the financial system. The apex banks of various countries have begun emphasising the need for greener financial tools. The World Economic Forum reported that the central bank of Sweden had even gone further in this pursuit, and initiated disinvestment in fossil fuel companies.



The green finance market has been at the highest it's ever been, with USD 1.002 Trillion in cumulative issuance of green bonds in 2021, since the concept was first introduced into the market in 2007, with USA, UK, France and China being the countries spearheading the table of numbers, among others.


A line graph reflecting the upward trend in the issuance of green bonds in billion USD from the years 2007 - 2020
Source: Climate Bonds Initiative

It is expected that the switch to a sustainable and green approach to the concepts of growth and development will reap high economic benefits, boosting the economy with a forecasted value of 26 to 30 trillion USD by the year 2030.


However, the green finance industry has an other-side-of-the-coin of its own. Companies use ESG strategies to get a better sense of how real-world crises affect their bottom line, but ESG ratings do not reflect a company's effect on the real world-they indicate how well it manages its risks. Among the climate-themed funds, more than half use phrases like "energy transition," "low carbon," and "clean energy" but do not align with the objectives of the Paris Agreement.


The following are the red flags to remain mindful of while looking at the green investment market:


1. Misalignment of Values

There remains a disparity between the objectives that a firm has in mind while making an investment decision and the priorities that the stakeholders have. Is the priority maximising their returns or are they prioritising minimising their impact on the environment? The trade-off between profits and social responsibility acts here. Despite the positive response given by ESG funds, they have been noticed to underperform as compared to conventional funds. by these funds. This has made investors impatient and anxious, leading them to withdraw their funds in anticipation of a loss. While making a decision to invest in an ESG fund, it becomes imperative that the investor analyse their priorities and keep the long-term objectives in perspective.



2. Inconsistent Measurement

The financial world today is facing a challenge in the form of a sophisticated system of measuring ESG performance. The current systems in place to measure the performance of an ESG fund remain lacking, is lethally narrow and fails to capture the vivid nuances of our social and environmental ecosystems. Furthermore, there is a deficiency of good-quality data about companies and their actions towards sustainability. The inconsistency exists due to different firms acting on different priorities and systems, with no standard on ESG measurement.


3. Misguided Investments

Investors often invest in stocks of companies they believe are good companies (or they might sell the stocks of a company they think is a bad company). This action is motivated by their belief that this would help change things. However, this does not really affect the way a company behaves or operates. The company might still engage in unethical, unsustainable practices. Instead of this, stakeholders should invest in a company and actively engage in engagement and lobbying to pressurise the management into behaving sustainably.

This argument is two-fold. One way that investments are misguided is the belief of the investors that if they divest a particular stock from a ‘bad’ company or if they purchase the stock of a ‘good’ company, they will be contributing towards the tangible change in society. However, this hypothesis is proven wrong because divesting or investing in a company does not influence the objectives, goals or behaviour of the company. Thus, active lobbying and shareholder engagement are key to pressurising the management into changing their beliefs. Secondly, several platforms, having recognised the popularity of ESG funds, have started misleading potential investors. By tagging funds as ‘ESG’, ‘green’, etc., investment platforms mislead investors into funding projects that may very well be socially and environmentally harmful.


4. Technical Jargon

The financial realm has often been steered clear off by people due to its plethora of technical terms, complex definitions and complicated webs. Several investors wanting to invest in a socially and environmentally sustainable project get discouraged from doing so, owing to the jargon that surrounds them.


5. Mass Greenwashing

Due to a lack of a standard metric system in place to measure a firm’s performance in terms of sustainability, many companies find it an attractive option to glorify their ‘ESG funds' and make them seem ‘greener’ than they actually might be. With the growth of the conscious sentiment among the public, it’s become imperative for companies to maintain their reputation and for investors to make sure that they are not attached to an unethical corporation. Excessively marketing a fund as ‘ESG, green and sustainable’, corporations greenwash the public into investing while retaining their image as a ‘good’ company. Furthermore, small investors trying to make conscious efforts towards sustainability often get roped into these phoney schemes.

To conclude, it becomes clear that there still remain several institutional challenges to be met in order to further boost the green market, and ensure that the sustainability that is promised is the end return on these investments. It is advised to small investors to do their research and make conscious decisions after thorough analysis and consultations. Don’t ignore the red flags, however small they might seem!


References

Baskin, K. (2021, June 23). 3 hurdles to sustainable investing — and how to overcome them. MIT Sloan.

Climate Bonds Initiative. (2020, December 15). $1Trillion Mark Reached in Global Cumulative Green Issuance: Climate Bonds Data Intelligence Reports: Latest Figures. https://www.climatebonds.net/2020/12/1trillion-mark-reached-global-cumulative-green-issuance-climate-bonds-data-intelligence

Financial Times. (2022, February 19). Green investing: the risk of a new mis-selling scandal. https://www.ft.com/content/ae78c05a-0481-4774-8f9b-d3f02e4f2c6f

Gunia, A. (2021, September 20). Many Green Funds Don't Live Up to Their Claims, Report Finds. TIME.

The World Economic Forum. (2020, November 9). What is green finance and why is it important? Retrieved May 18, 2022, from

The World Economic Forum. (2019, September 12). Green finance is transforming global investment for a low-carbon future.


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