Greenwashing: caveat investor

Key takeaways

• The number of sustainable investment options is rising dramatically
• Yet sustainable claims are currently no more than assertions
• Investors need to be aware of the dangers posed by greenwashing
• Regulators’ recent labelling interventions can help in decision-making
• Ultimately, investors have a responsibility to challenge assertions in order to match their sustainable investment goals.

Sustainable investing is probably one of the most important investment themes facing investors in the next few years and beyond. According to data from Morningstar, in Europe alone, asset managers launched a record number of 505 new sustainable funds and repurposed more than 250 conventional funds¹.

Yet without agreed definitions, many of those funds use different sustainable approaches and labels. So how can investors understand and avoid the risks of so-called greenwashing?

Greenwashing refers to the “practice of over-emphasising a company's environmental credentials, often by misinforming the public or understating potentially harmful activities”².

With a lack of deep knowledge or authentic commitment, there is a risk of greenwashing. As a result, investors may be misled, inadvertently or not, to buy products where the advertised sustainability approach or outcomes does not match the reality.

Recognising this issue governments, regulators and policymakers are starting to step into the field.

At the forefront, the EU has introduced a classification system to determine what counts as green and sustainable activities. Rules have also been initiated for the investment industry, known as the sustainable finance disclosure regulations (SFDR).

These rules create three classifications of funds – “Article 8” products which actively include and promote environmental or social characteristics (sometimes known as “Light Green”); “Article 9” products which have specific sustainable outcomes as part of their objectives (similarly known as “Dark Green”); and “Article 6” which do not actively incorporate sustainability, or at least do not promote it to investors.

It is crucial for investors to decide what they hope to achieve. Are they aiming to avoid companies that don’t reflect their values? Or to use ESG factors to identify better run companies? Or is the investment designed to mitigate climate breakdown, or support the UN Sustainable Development Goals? All these options are valid; each has its own sustainability implications.

If greenwashing is due to the misalignment between what is represented and the reality, then investors should query and challenge in order to understand the underlying process, not just the outcome presented.

Labelling can make it easier to identify categories of investment approaches; and provide greater visibility and comparability of options. However, the level of skill or quality of an investment manager can’t be determined by a label.

To solve the urgent social and environmental problems facing economies, innovation on a large scale is critical. Hopefully, the risk of greenwashing will diminish and not prevent the flow of more private capital into those innovative opportunities that can preserve and grow wealth and make a positive contribution to our world.

With rapidly growing supply, and marketing, of sustainable investing products, investors need to be more aware of greenwashing and how to mitigate this risk.

Sustainable investing continues to gather momentum as probably one of the most important investment themes facing investors. The area has gone from one frequently disregarded a few years ago, to one arguably at the start of an “environmental, social and corporate governance (ESG) bubble”, as highlighted in March’s Market Perspectives, augmenting capital flows and valuations.

According to data from Morningstar, in Europe alone, asset managers launched a record number of 505 new sustainable funds and repurposed more than 250 conventional funds¹. Based on this universe, there are now about three times as many sustainable funds as just four years ago.

Varied approaches to sustainable investing

Notably, without a common or agreed definition and terminology, many of those funds use different sustainable approaches and labels. Moreover, with recognition of increased investor demand, marketing of green or sustainable investment credentials has ballooned as well.

However, despite being “on trend”, there is a risk that some investors may be selling the Emperor’s New Clothes. So how can investors understand and avoid the risks of so- called greenwashing?

Corporate greenwashing

Greenwashing refers to the “practice of over-emphasising a company’s environmental credentials, often by misinforming the public or understating potentially harmful activities”².

Historically, greenwashing charges have been levelled at companies who have attempted to position or promote their brand as more environmentally friendly than the reality of their businesses. Similarly, companies seeking to capitalise on demand for sustainable products have marketed their products with green or healthy labels where underlying processes or materials are not. As these organisations have been called out, their reputations have suffered.

Growth of greenwashing risk

Growing investor awareness and concern over the need to address social and environmental issues is driving more interest in sustainable investing. In responding to this client demand, and a desire to play a positive role, investment houses are seeing a potential commercial benefit.

With a lack of deep knowledge or authentic commitment, there is a risk of greenwashing. As a result, investors may be misled, inadvertently or not, to buy products where the advertised sustainability approach or outcomes does not match the reality.

As an emergent and rapidly evolving field, understanding and evaluating what investment managers are actually doing is difficult. Without experience or a guide, investors can struggle to navigate the field and select the most appropriate managers.

Regulators to the rescue?

Recognising this issue governments, regulators and policymakers are starting to step into the field.

At the forefront, the EU has been focusing on making the financial system more sustainable over the last several years. As part of a series of reforms, it has introduced a classification system, or EU Taxonomy, to determine what counts as green and sustainable activities.

Rules have also been initiated for the investment industry, known as the sustainable finance disclosure regulations (SFDR).

SFDR regulations require all asset managers to publish information on how they incorporate sustainability into their investment processes – with the aim of reducing the risk of greenwashing.

These rules create three classifications of funds – “Article 8” products which actively include and promote environmental or social characteristics (sometimes known as “Light Green”); “Article 9” products which have specific sustainable outcomes as part of their objectives (similarly known as “Dark Green”); and “Article 6” which do not actively incorporate sustainability, or at least do not promote it to investors.

While this classification can be helpful, fund managers only started self-categorising their investment products in March. So differences in the approaches to sustainability are likely until all managers start reporting under the SFDR rules, and subsequent industry and regulatory conversations occur.

Taking ownership

With increased disclosures and further industry convergence, investors should find it easier to avoid greenwashing and identify truly sustainable and green investments. However, these changes will take time to implement and normalise.

Moreover, with a preponderance of funds being marketed as sustainable, investors need to know how to find those that are worthy of their capital. Below are some actions investors might take to avoid greenwashing in the interim.

Articulate your preferences

To some extent, sustainability is in the eye of the beholder. Therefore, beyond understanding the different approaches, it is critical to know what investors want from their portfolio. Without this clarity it is easier to accept a greenwashed offering.

In selecting sustainable investments are investors aiming to avoid companies that don’t align with their values? Or are they looking to use ESG factors to identify better run companies? Or, finally, is the investment designed to mitigate climate breakdown, or support the UN Sustainable Development Goals? All these options are valid; each has its own sustainability implications.

Investors should take time to discuss, consider and articulate their preferences. This can be particularly important with family members and intergenerational considerations. Making this clear with your investment statement or policy helps compare and hopefully match the products you want with the approach they take.

Understand the process, not the presentation

If greenwashing is unintentionally due to the misalignment between what is represented and the reality, investors also have a responsibility to ask enough to confirm their understanding.

What is presented in a marketing document, or even an impact report, is a snapshot of either a moment or period of time. It is often partial and is always backwards looking. Portfolios can have high ESG scores by circumstance rather than planned effort.

Investors should query and challenge to understand the underlying process, not just the outcome presented. Whether investment managers can clearly explain their process, its depth and robustness, is often a simple test to see if there is greenwashing happening.

Trust but verify

We counsel our children, even when the walk signal turns green, to check for themselves before crossing the street. Similarly, simply having any label should not mean that investors relinquish their own insight.

Labelling can make it easier to identify categories of investment approaches; and provide greater visibility and comparability of options. However, the level of skill or quality of an investment manager can’t be determined by a label. Nor whether their approach matches with your aforementioned preferences.

This means investors need to look again before going forward. For example, tagging UN Sustainable Development Goals in presentations has become common practice.

Being able to articulate how, and how much, the underlying company has contributed to them less so. As valuable as knowing what’s in the portfolio is why holdings have been sold or what, at the final stage, did not make it in.

Investment in sustainable innovation key

In the end, while our aim has been to help investors to understand and avoid greenwashing, the reality is that not every sustainable outcome occurs as intended.

To solve the urgent social and environmental problems facing economies, innovation on a large scale will be critical, including in the investment sector. Hopefully, the risk of greenwashing will diminish and not prevent the flow of more private capital into those opportunities that can preserve and grow wealth and make a positive contribution to our world.