ESG has been rising in popularity worldwide, though the space remains fragmented due to a lack of consistency and standards. That means individuals who want to invest responsibly must watch out for brown issuer companies that engage in greenwashing.
As if things weren’t confusing enough, there’s evidence to suggest that some funds are ESG in name only. “[W]hile stock market returns were basically flat in 2018, ESG funds pulled in nearly $5.5 billion of new money during the year and already a record $8.9 billion in the first half of this year,” reported WealthManagement.com, citing data from Morningstar.
But according to the news outlet, a good portion of the assets are held in funds were simply “repurposed” to include an ESG mandate. That includes some managers peppering plain-vanilla funds’ prospectuses with verbiage about using ESG criteria without meaningfully changing the fund’s holdings.
“The assets didn’t come into those intentionally because of the ESG mandate,” Neil Bathon, founder and partner at FUSE Research, told WealthManagement.com. “When you strip away the noise that’s in the data, you realize that there’s very little evidence one can point to suggest momentum for ESG offerings.”
In its Sustainable Funds US Landscape report, Morningstar said that out of the US$161 billion amassed in ESG funds by the end of last year, US$72 billion was held in repurposed funds. The firm said 62 existing funds added ESG criteria to their prospectuses for the first time last year, but only 11 underwent “a complete makeover” with changes in the funds’ holdings.
“Transforming funds into sustainable offerings is a way for asset managers to build their sustainable investing business without creating new funds from scratch and having to wait for them to reach scale,” Jon Hale, director of sustainability investing research at Morningstar, wrote in the report. He suggested that investors’ massive move to passive products have left many asset managers with an inventory of active funds that are losing capital faster than they can attract it.
Numerous other funds — including many held by Aberdeen, J.P. Morgan, and Morgan Stanley — just had “ESG considerations” added to their prospectuses without necessarily making a corresponding change in portfolios.
“These ‘ESG consideration’ strategies do not go as far in their commitment to sustainable investing as those that have been completely retooled,” Morningstar said, adding that the growing number of such products indicates the growing role of ESG criteria as a standard complement many existing investment processes.
“It’s important to ask questions … to really understand whether ESG is really core to the fund's manager's process, or whether it's just something that's added on as a paragraph in a perspective or a page in a pitchbook,” said Daniel Kern, chief investment strategist at TFC Financial Management.
For instance, some products that tout themselves as ESG-oriented may simply be excluding certain types of “sin stocks,” as opposed to a more active approach that evaluates a firm’s ESG criteria, pursues a sustainability-related theme, or aims for a measurable impact alongside financial returns.
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