What is greenwashing and how can it be avoided?

Is a fund sustainable just because it says it is? That is the essential question behind the topic of this article: greenwashing. A word that has even earned its place in Meriam-Webster, which defines it as, “expressions of environmentalist concerns especially as a cover for products, policies, or activities”.

Think of greenwashing as an asset manager adding a thin coat of sustainability – a so-called “green sheen” – to a fund. The main purpose? To attract the growing number of investors interested in sustainable investing. It is a cynical approach, designed to exploit the fact that no precise standardised definitions on what qualifies as sustainable investing yet exists.

The downside is that it underpins the accusation that sustainable investing is nothing more than a branding exercise. Greenwashing muddies the sustainable investing label. So much so that the US Securities and Exchange Commission is considering updating its Names Rule (which sets out the relationship between a fund’s name and its required investment policy) to stamp out this practice.

While avoiding greenwashing can be tricky, a good way to start is by asking three key questions:

Question #1: Does the asset manager subscribe to integrated sustainable investing thinking?

“Integrated sustainable investing thinking” is really just a term to describe the process of applying a “sustainability lens” at all stages of the investment process. The opposite of this would be an asset manager that does little more than apply a basic ESG screen – excluding “sin industry” stocks – and deems itself sustainable.

Again, the challenge here is that there is no universally accepted method of carrying out such integration. A good idea is for sustainable investors to dive into a particular fund’s fact sheet and carefully examine the section on its investment-selection process.

There are a few things to keep an eye out for: look at the sustainability measures being used to assess the companies held in the fund. A red flag – particularly in actively-managed funds – is the “outsourcing” of the sustainability analysis part to third parties and blindly following external ratings. Investors want to see if the manager is dedicating actual resources to ensure that the companies it invests in are green both on the outside and within.

That said, there are external measures that can serve as valuable guideposts – particularly for measuring impact. A good example would be the UN’s official indicators for its Sustainable Development Goals (SDGs). These provide detailed and specific methods to track progress across each goal. However, they cannot be adopted as an afterthought. Instead, the asset manager should integrate such indicators into its broader investment process.

A glance through some of the fund’s top holdings can also prove helpful. There may be a name that triggers a “spider sense” – which might be a signal to investigate further.

Question #2: Is the asset manager engaging with companies to drive change that will boost sustainability?

At an institutional level, part of being a sustainable investor is accepting the responsibility that comes with being a shareholder too. Investors are often among the largest shareholders of portfolio companies and have a responsibility to try and drive sustainability-related change.

It is almost impossible to greenwash if an asset manager actively engages with companies. Lines of investigation should include:

  • The number of companies the manager actively engages with
  • The number of shareholder meetings at which it votes, and how it votes
  • The number of meetings on sustainability issues it has conducted with its portfolio companies, plus consistent follow-up and tracking on issues raised
  • A breakdown of how it engages with its portfolio companies across regions, sectors, and themes (environmental, social, or governance)

An excellent place to look for this information is in the asset manager’s annual sustainability report. If there isn’t such a report – or it doesn’t contain sufficient detail – that may be a warning sign of potential greenwashing.

Question #3: Is the asset manager “walking the talk”?

The final level is to look beyond the manager’s behaviour toward its portfolios and study how it practices sustainable values.

This can involve scrutinising the asset manager through a sustainability lens. Its mission, work environment, employment practices, carbon footprint minimisation measures, and community initiatives are just some things to look at when doing so. Of course, it is possible for an asset manager to only invest in genuinely sustainable companies – while not taking the same approach itself. However, this is highly unlikely: a steadfast commitment to sustainability starts from within.

Investor education is vital, but regulations are also likely on the way

At its core, greenwashing is a “truth in advertising” problem. Such issues are usually solved by a combination of bottom-up investor education and top-down regulations. This article is about the first – but the second is also likely on the way. For example, the European Union’s upcoming Taxonomy Regulation on sustainable investments, which came into effect in June 2020, is expected to have wide-ranging implications for financial institutions.

Regulators in Asia such as Hong Kong, Singapore and Japan, are also more actively implementing new requirements on sustainable finance, with an emphasis on improving regulatory framework for ESG governance and disclosure in Asia.

Still, regulations take time. Meanwhile, the best way to avoid being greenwashed is to do two things – know the right questions to ask and be willing to do some homework.