25 JAN, 2023
By RankiaPro Europe
Greenwashing is a deceptive practice in which a company presents itself as more sustainable than it really is, which can lead to misguided or ill-founded investments. Therefore, the key question is how to avoid greenwashing: in this article, three experts share their knowledge and experience on how to identify greenwashing practices, and offer practical tips for investing in sustainable companies.
Recognizing greenwashing can be a difficult and laborious task. However, there are several warning signs to look out for. First, it is important to ensure that a relevant ESG approach is in place for the strategy in question and that the ESG criteria actually influence portfolio construction. Not all ESG approaches are suitable for all strategies. The mere application of an exclusion filter, for example, may serve as a useful risk tool, but does not create a direct sustainable impact.
If a product that previously did not apply any sustainability criteria is suddenly positioned as an ESG product without any change having been made to the investment process, this is a clear red flag. The use of vague or ambiguous statements rather than facts in the description of the ESG process can also serve as an indicator of possible greenwashing.
In addition to in-house analysis, external sustainability labels can be useful when comparing different products. The FNG label, for example, is especially useful because there are different levels (stars) that funds can receive if their sustainability approach exceeds the minimum criteria.
Finally, it is to be hoped that the new classification rules provided for in the Sustainable Financial Disclosure Regulation will be of great help in avoiding greenwashing and allowing investors to assess and compare the sustainability profile of different ESG investment products.
It is difficult to prevent greenwashing when there is no consensus on the definition of sustainability or sustainable investment, the definitions that emerge are ambiguous (I invite you to reflect on the recent definition published by the ISSB reporting standard) or still leave many aspects to free interpretation. Moreover, greenwashing can be applied to companies, valuation techniques, reporting methodology, investment products, marketing and advertising, employee training, etc.
If the subjective component is still very high, considering that one is engaging in greenwashing will therefore also be very high, so one must be very cautious when accusing a company, department, entity, or employee since the reputational risk and the damage that can be done is very high.
The key to trying to avoid greenwashing is, as in any investment to be made, to carry out a rigorous analysis where questioning is the cornerstone: do not take anything for granted, contrast all information with different sources, and analyze the company or product from different perspectives. That is why it is important to have a systematic model of analysis and to have a team with diverse profiles.
At Portocolom AV, we have developed our own analysis model to detect those companies that want to improve their practices, those that have a commitment and over time are fulfilling it. We not only analyze whether the economic, social, and governance data published by companies correspond to what they actually do (controversies), but we also analyze the direct and indirect, positive and negative impact of companies in each of the Sustainable Development Goals. In this way, we end up analyzing each company from 22 different sustainability points of view. We look for businesses whose objective is to try to do things in an increasingly responsible way, not only maximizing value for their shareholders, but also for the environment.
Sustainability is a relatively recent trend. This is why strategies that only apply exclusions are not truly sustainable. We often forget that on the road to sustainability, there must be a progressive and orderly transition so that this improvement is “sustainable” and allows all types of companies, large-cap or small, from developed or emerging countries, to adapt to the new environment.
If you exclude a sector as a whole, you do not give it the opportunity to reinvent itself, and right now, sustainability is a trend that has emerged relatively recently. Companies need to be given a chance to operate in a framework of conditions that are not the same as they were ten years ago. The ultimate goal is to provide investors with transparency so that they can make more informed investment decisions. For Portocolom AV, where a large part of our clients are and have been religious congregations and foundations from the beginning, we have always kept this in mind.
Recent years have seen a growing interest in sustainable investing. Accompanying a growing demand from investors and a regulatory push, managers are increasing their offering of sustainable funds and companies that are respectful of people and the environment are also proliferating. However, we have also seen an increase in “greenwashing”, an intentionally misleading communication that exaggerates the sustainable nature of an investment product, sometimes detracting from the credibility of sustainable investing.
At Schroders, we believe that the best weapons to combat greenwashing are information and education. In terms of the information available, regulators and policymakers are making transparency a top priority because, like investors, they see a lack of consensus and data as a potential barrier to market growth.
However, despite all the new information being released, we still see a lack of understanding and confidence on the part of investors. This is where financial education on sustainable matters takes center stage, starting with improving the language being used and accepting that 100% equivalence will be difficult to achieve, as sustainable investing is an umbrella term that encompasses many different approaches.
The investment industry must continue to strive and, in this endeavor, it will require both the discipline of those who report and communicate on their sustainability, as well as training those who use these reports and publications to understand and challenge them, thus avoiding greenwashing. At Schroders we are very involved with our clients, and we are available to share insights and knowledge.
With the rise of new sustainable funds, the question of how to avoid greenwashing is gaining importance. This is attracting a lot of media attention. Socially Responsible Investment (SRI) labels are popping up everywhere, and the EU is in the process of defining its own ecolabel. In the past, a fund was simply labeled as (socially) responsible, where appropriate, but now the market is making distinctions as to the different ways in which sustainability can be applied. For my part, I will offer my perspective in this column.
Let’s start with the easy part: strategies that only apply simple exclusions and still qualify as sustainable should be a thing of the past. On the other hand, investing sustainably is much more difficult than buying a set of ESG scores and applying them to a portfolio. Sustainable investing is much more. Let’s talk, for example, about new forms of sustainable investing, and the dilemmas posed by greenwashing.
Clearly, there are areas that sustainable investors seek to avoid, such as tobacco, weapons, non-compliance with basic working conditions and human rights, as well as certain types of fossil fuels, such as thermal coal. But there are other, less clear-cut issues. Traditional fossil fuels, for example, have a major impact on climate change. Yet they continue to be needed and widely used. Some believe that energy companies are as much part of the problem as part of the solution. Others simply choose to avoid them. The question is whether maintaining investment in these companies and interacting with them may be better for promoting their transformation, rather than moving away from them.
Secondly, in my opinion, a strategy is only truly sustainable if it is also financially sustainable. It is therefore important to adopt an integrative mindset. It is worth asking how the various long-term ESG trends and their associated external costs, such as climate change, declining biodiversity and increasing inequality, can lead to changes in business models. ESG investing is no longer limited to narrowing the investment universe to the “best-scoring” companies. It involves a lot of thinking about sustainability and how it affects companies and investment strategies. To give an example: in all our quantitative strategies, when two stocks score equally (financially) on a factor, a higher weighting is given to the one with the better ESG score. In our fundamental strategies, the ESG criteria affect the valuation, i.e. the target price. For example, data protection and data management by Internet companies is already taken into account in the valuation model long before it becomes an issue. The same applies to pricing in the healthcare sector.
Another way of implementing sustainability is through active share ownership (active ownership). Robeco has been an active holder for 15 years. We have a very structured approach to address issues that other investors don’t even know are there, such as the data protection interactions we started in 2015. This year, we are starting to interact in the areas of digital healthcare and the social impact of artificial intelligence. These are two very long-term issues and relate to both new technologies and sustainability: in the first case, we are looking to tackle the increase in healthcare spending and, in the second, to analyze the social risks that may arise in the long term.
Last year, our team of 13 specialists developed interactions with 214 companies. The interaction takes place over a three-year period, allowing us to track and quantify the companies’ progress. Some wealth managers claim to interact with 2,000 companies a year. In my opinion, they can’t be talking about more than raising a question or two about ESG at a regular meeting, or sending a form letter. It takes considerable resources to get to do this reasonably effectively.
The exercise of voting rights is another interesting issue. Studies show that some of the largest (passive) investors almost always vote in line with management recommendations, even on proposed environmental and social resolutions. I believe this raises questions about the credibility of the manager. For our part, we believe that the social and environmental proposals presented at meetings are increasingly better formulated and aligned with the creation of long-term shareholder value. As a result, last year we voted in favor of such proposals in 72% and 78% of cases, respectively.