Due to the challenges of the availability of accurate and complete data in assessing the effect in the sustainable investing space, the practice of ‘greenwashing’ has grown.

Greenwashing is the practice of giving the wrong impression, providing false information, or fabricating a story about how a company and its products, or an investment solution, are environmentally friendly or beneficial in an environmental, social or governance (ESG) context.

There is some concern that recent large inflows into ESG solutions may not be based on complete information and that, if results disappoint, or if practitioners are seen to be greenwashing, a backlash may result.

Greenwashing in the Investment Management industry

The growth of interest in ESG-related investment strategies is an incentive to create an investment solution that ‘looks green’ rather than one that reflects a meaningful commitment to a strategy with meaningful implementation of relevant ESG dimensions.

The EDHEC Business School recently produced a report on detecting greenwashing in climate investing. Its argument is that most climate-related portfolios have investment strategies that are closet ‘business as usual’ due primarily to their unwillingness to deviate from the traditional market capitalisation benchmarks.

Given this constraint, the effects of climate-related metrics on the overall portfolio weightings are vanishingly small. In addition, they show that the share-specific climate ratings are not consistently reflected in the portfolio’s active positions (ie deviations from the benchmark weightings) over time. This is deemed to be inconsistent with consistent implementation of the ostensible climate mandate of the portfolio.

It is possible, however, that the more pragmatic explanation is possible – the climate mandate is not the only requirement of the portfolio – other share-specific factors can also affect the choice of weightings in the portfolio. This suggests that the effective extent of the greenwashing will be determined by the mandate of the portfolio, which includes the benchmark and tracking error limits (if any).

What can you do to avoid greenwashing?

Unfortunately, greenwashing is real. The following factors should be considered by investors when considering an investment in a specific company:

ESG needs to be made very specific to the company’s context and strategy. The company needs to explain which ESG issues it is tackling and why and how that ultimately affects its value chain.
ESG should be integrated with all company activities, meaning it should be clearly part of the company’s strategy, its risk considerations and the practice of its board’s oversight duties.

From an investment perspective, investors should do the ‘smell test’ as highlighted by Karen Wallace, director of investor education at Morningstar. This means investors should simply read up on the portfolio they are looking to invest in. This will highlight what the objectives are and, more importantly, the companies invested in. The investor can therefore determine if the portfolio is aligned with their own ESG objectives or criteria. The mandate and the benchmark of the portfolio need to be considered as well as other constraints, such as the extent the investment manager can deviate from the benchmark (ie, its tracking error).Finally, if the portfolio is using any metrics for assessing its investment status on an ESG basis, these metrics should be certified by an independent third party.

Greenwashing and Momentum Investments

Momentum Investments actively integrates ESG and other RI-related considerations into the portfolio management of both our single and multi-asset class solutions.

We also review the Responsible Investing (RI) practices of all the external investment management companies used in our portfolio solutions on an annual basis. The specific methodology used, and findings made is available on the ‘Rating our investment managers’ report. In short, we actively seek to avoid greenwashing on behalf of our clients by assessing the extent to which the ESG and other RI-related investment practices of investment managers match their rhetoric.

We also support and welcome the development of a green finance taxonomy for South Africa. This is a catalogue that defines a minimum set of assets, projects and sectors that are eligible to be defined as ‘green’ in line with international best practices

and national priorities. This initiative will also help curb greenwashing, and the disclosure practices will enable transparency and accountability among all market participants.

ENDS

Article written and co-authored by: