Investors love ESG. They cannot have enough of it.
At the beginning of 2021, one-third of the global assets under professional management were sustainable. In other words, globally, $1 of every $3 was invested in a green asset (source: Morgan Stanley). As a consequence, sustainable investments climbed ( source: US SIF) 42% in value compared to 2019.
For those who do not know, ESG portfolios comprise funds that are invested in companies that believe in sustainability – a commitment to reducing their environmental, social, and governance impact. Such companies claim to go carbon-neutral by 2050 and prioritize the welfare of all stakeholders including employees, customers, and suppliers.
That said, it is quite hard to say whether such companies sincerely intend to improve sustainability and bring honest change or pander to modern investors. Look at these stats.
A 42% rise propelled sustainability investments to a high of $17 trillion. Merrill Lynch, in fact, estimates that the figure will be greater than $20 trillion in the coming decades. This seems especially convincing when we consider the fact that Biden urged the country’s largest companies to achieve carbon neutrality by 2050. It is estimated that by then, more than 60% of the world’s economy would have followed suit.
ESG indexes are already outperforming (source: Morningstar) their peers, showing signs of immense confidence and growth. Nearly one-fifth of all S&P 500 earnings calls and inquiries cite (source: FactSet) non-financial ESG data.
Such astounding facts and figures ring alarm bells, and they should. Do investors find such investments truly meaningful or are they dazzled by the hype, riding yet another tide? To flip the question, are companies truly making a sustainable change or are they greenwashing?
What is greenwashing?
Greenwashing is the art of making oneself appear more sustainable or green than one really is.
In polite terms, greenwashing represents a cover, an excellent exercise in PR and corporate marketing – pandering to modern investors and customers who increasingly advocate for responsible, sustainable investing.
Bluntly, it is a misleading lie – hypocritical and fairly unethical.
The unfortunate truth is that quite a sizable share of companies do engage in greenwashing. The Climate Bond Initiative (CBI), a not-for-profit initiative to encourage sustainable and resilient investments, found that out of the $140 billion worth of sustainable debt funds tracked in 2020, only 21% were certifiably green. The rest were merely labeled green and had a few shades here and there. Those were greenwashed.
Take Tesla, for example, the electric car giant renowned for its sustainability claims. Only two of its three debt offerings were approved as green investments.
Like Tesla, there are dozens of companies that have exaggerated their ESG impact or outright contradicted it.
Amazon, for example, has been consistently accused of having poor or harsh working conditions. Its employees are unhappy and appallingly micromanaged. Even accusations of union crushing have surfaced! Such instances emerged, despite its CEO, Jeff Bezos signing the Statement on the Purpose of a Corporation announced by the Business Roundtable. It indicates his commitment to the welfare of its customers, employees, shareholders, suppliers, communities, and so forth alike. In fact, a month after Bezos signed the statement, Amazon terminated the health insurance of more than 1900 part-time Whole Foods associates!
Another CEO who signed the statement was American Airlines’ William Parker. The airline leviathan, though, has had a nefarious reputation for violating labor laws accused by its mechanics of lower pay and harsh working conditions.
The list is quite long.
Wells Fargo, which claims to champion ESG programs, was found to deploy aggressive tactics to cross-sell their products. In an investigation, its employees revealed that the tactics were devised to achieve the ridiculously high targets set by their managers. Many were, in fact, fired because they opened accounts without the knowledge of customers, often forging their signatures. The above instance signifies anything but good governance.
In 2019, Johnson & Johnson faced a lawsuit that accused the multinational Pharmaceutical giant of downplaying the risks of one of its products. In 2013, the company was fined $2.2 billion for similar charges of improper marketing and not making warnings clear enough.
Next is the case of Larry Fink, the chief executive of BlackRock. Fink has been an ardent advocate of sustainable or ESG investing for years. However, it was found that out of the $7.8 trillion worth of funds he managed, nearly $85 billion worth of funds were composed of coal investments. Although an insignificant amount, it shows a positive move. Why not go the whole way?
The examples above show the cunning of these companies and many others in painting a more positive picture of themselves than reality. They falsely project themselves as climate-friendly, equal, inclusive, ethical, trustworthy, responsible, accountable, secure, and endowed with all the virtues associated with sustainability. The perception, however, works wonders for their stock prices.
The above-mentioned scenario is an example of greenwashing 101.
However, before your trust is fully eroded in them, understand that the problem is much murkier than it seems.
How sustainable investments are greenwashed
Unlike BlackRock, there are companies that can go the whole way. There are companies that can properly integrate ESG in their strategy. It’s not that they won’t, but they cannot.
The biggest challenge to materiality assessment in ESG is to identify what constitutes ESG.
Yes, that is right. There is no official consensus as to what going the whole way means. There is no agreement as to which factors ought to be identified and analyzed to determine whether a company or organization has properly integrated ESG in its strategy.
At SG Analytics, for example, ESG consulting involves the analysis of hundreds and thousands of different factors across a variety of areas to determine the most favorable sustainability practices.
In fact, all industry leaders identify the most lucrative sustainable investments in this manner. They first identify hundreds of factors that they believe drive sustainability. Then, they thoroughly study companies, collecting their data in relation to those factors. The data points, which can be in the range of thousands, are used to create a score or scale to rank companies based on their estimated sustainability.
However, since there are no official, established guidelines, every ESG consulting firm relies on the quality of its own research. Hence, the market is replete with ESG scores, and one company may have two different scores as the scores consider different factors in their assessment.
Hence greenwashing is widespread either because companies make an honest mistake by confusing factors or they intentionally exploit the ambiguity in the definition of ESG. Broadly, greenwashing happens by either of the two ways mentioned below with instances.
Excluding or obfuscating information that may negatively affect an ESG score: Recently, Apple decided to ship its iPhones without chargers. As one would expect, critics of Apple exploded. Earlier, when it removed the headphone jack, Apple explained that the jack had to be removed to make the phone thinner. However, when the company removed the charger, it explained that the objective was to reduce e-waste and save the environment. The explanation is baffling because Apple then proceeded to sell its next generation of chargers, separately. As The Verge concluded, Apple ditched chargers to save costs, not the planet.
Including extremely few green prospects, and yet labeling the entire fund sustainable: Vanguard, a Pennsylvania-based investment advisor managing assets worth $6.2 trillion released two highly rated ESG funds. However, a report highlighted that nearly thirty stocks were greenwashed. Vanguard dropped the stocks immediately.
(It must be added that in the second case, a fund manager may include a fund that they think improves sustainability. However, committees such as CBI would disagree and consider an investment in such a fund as greenwashed.)
In this manner, ESG scores are distorted and ESG investors may be misled.
The question is, who is to blame here? The companies that falsely label themselves as green or the ESG asset managers who fail to filter out greenwashed sustainable funds?
Well, the answer is, of course, both.
How to avoid Greenwashing?
The problem is clearly the lack of standards, and establishing standards is precisely how greenwashing of sustainable investments can be discouraged.
Here are a few standards we think might help.
Absolute standards: Just owning less than 1% of ESG assets does not make an investment sustainable. ESG investing must be absolute – involving all or nothing.
Active ownership: ESG investing must not be passive. Instead, investors and in fact, all stakeholders must take active ownership, regularly voting and engaging in decision-making. Such an environment distinguishes companies that are making an honest change from those merely pretending to do so.
Agreement on factors: Active ownership is only possible if the stakeholders agree on the factors that constitute true and meaningful ESG data.
Standardized terms: To understand those factors and their impact on sustainability, stakeholders must understand the terms that define them. Therefore, the terms must be defined with full clarity and transparency so that nothing is left ambiguous.
Government regulation: Like it or not, regulations could be of immense help. In Europe, the EU is already stepping in to separate the green from the greenwashed.
ESG investing is a great way to promote biodiversity, equality, inclusion, green energy, and all the positive changes that will make the world a better place. However, until these changes are made, we will never know which companies truly care and share our vision and which companies are running a ‘marketing campaign.
Until then, ESG investors must be mindful, thorough, and careful in their research. Or, they could get in touch with us, the real experts who know their job.
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