How to spot when you are in the presence of greenwashing

By Elena Tedesco, senior portfolio manager, Vontobel

As ESG flows continue to rise, regulators acknowledge this segment deserves more attention. Several countries are adding rules to protect investors and ensure the funds and ETFs they buy ‘do what they say on the tin’.

The concept of transparent and consumer protection is well rooted in many sectors, starting from the food sector, where sellers cannot call a drink ‘champagne’ unless it is produced in the famous French region and meets certain requirements. Ditto for Parmigiano Reggiano and so on; the same goes for ESG funds.

Rules help, and enforcement and investigations will deter market players from abusing the term. We expect regulators to continue catching up with the real economy on this front and adopt more laws and tools to cover the deep realm of ESG investing.

However, rules alone are not enough, because ESG investing means different things to different people depending on their beliefs and risk appetite. Some care about labour rights more than climate change; others want to use exclusions to avoid allocating capital to ‘sin sectors’ such as gambling and alcohol; some want to invest in the ‘just transition’ of our economies to a more sustainable paradigm.

Given the multitude of approaches, a sensitive way to avoid greenwashing is looking under the bonnet of those funds and ETFs under scrutiny. A fund that has a climate (Paris aligned) objective but invests in fossil fuel companies, should raise eyebrows.

If the fund has a transition and innovation objective, its clients probably expect something more revolutionary than waste management solutions based on leaving waste in landfills. If the target is improving living standards in emerging markets, it makes little sense to invest in Asian casinos and video gaming companies. And unfortunately, looking at ESG ratings alone doesn’t help here because many of them are constructed for sector neutral funds, i.e., they aim to identify the best companies in a given sector even if the sector is, say, weapons manufacturing or fossil fuel.

When it comes to impact investing in companies that do something ‘good’ for the planet or society—which is generally seen as the highest level of sustainable investing (beyond approaches based solely on ESG integration or ESG engagement) —the UN Sustainable Development Goals (SDGs) provide a helpful framework for setting investment goals and measuring outcomes.

Impact equity funds should include only companies that generate a significant part of their revenues from selling products or services that represent real solutions to sustainability problems. The focus on what a company does – via products and services’ revenues – has the advantage of being more clear-cut than an approach that focuses primarily on how a company operates. Indeed, the former approach would not allow investments in gold mining or luxury goods because these goods do little to fight hunger, improve gender parity or any other of the SDGs. The SDGs can be translated into investment areas that are tied to concrete key performance indicators (KPIs) against which the holdings can be evaluated.

ESG investing has come a long way and given the amount of regulation and focus on this segment, we may start to see the beginning of the end of greenwashing. The main catalyst to speed up such process seems to be the current economic scenario, as now more than ever we need real action to tackle the energy/food crisis deriving from the war in Ukraine and the pandemic.

Our societies can no longer accept greenwashing slogans. We urgently need products and services that can help us achieve the change necessary for a more socially just, economically inclusive, and environmentally restorative world.