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The challenges in looking under the hood

There are two major challenges investors face when ‘looking under the hood’ to assess the merits of individual ESG investments.

The first is a widespread lack of transparency in relevant data about investments made and outcomes achieved.

The second is a lack of consistency in methodologies, reporting and ratings. Some estimates suggest there are around 600 different ESG approaches being used today38.

Some methodologies to rate companies on against ESG criteria can be counterintuitive. In one high profile example39, Mcdonalds Corporation was given an improved ESG rating when the ratings agency dropped carbon emissions as an assessment criterion and determined that climate change neither posed a risk nor offered opportunities to the company’s bottom line. In other words, they assessed the risk the company faced from the world, not the risk the world faced from the company!

While progress has been made in this area, with initiatives such as the Task Force on Climate-Related Financial Disclosures (TCFD) and the Partnership for Carbon Accounting Financials (PCAF), the hitherto lack of harmonisation and standardisation has created the opportunity for some companies and funds to claim green credentials on tenuous grounds. (Should a fund that merely excludes alcohol, tobacco, firearms, and gambling be entitled to call itself ethical? Is that what investors would expect?).

Greenwashing

The potential for funds to overstate the extent to which they are environmentally friendly, sustainable, or ethical is referred to in the market as ‘greenwashing’.

In Australia, the RIAA estimates only 25% of the investment managers who say they invest responsibly can actually prove their credentials40.

There is growing global unease about the risks of greenwashing of financial products, and international regulators have established a Sustainable Finance Task Force that covers greenwashing and other investor protection concerns. ASIC is participating in this task force, and in July 2021 they announced their intentions to conduct a review of environmentally focused investment funds in Australia41

Added to the underlying challenge of assessing diverse and complex instruments and there is little wonder that individual investors need advice in this area.

As Nathan Fradley put it, this is a field that calls not just for active management, but for ‘active advice’.

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Find out how to invest your client's wealth ethically

38

‘Are universal sustainability standards and ESG reporting the key to net zero?’, Felicia Jackson, forbes.com, October 2021.

39

The ESG Mirage, bloomberg.com, December 2021.

40

Pressure mounts on funds to come clean about being green, John Collett, Sydney Morning Herald, October 2021.

41

ASIC to review ESG funds for greenwashing, Tara McCabe, mozo.com.au, July 2021.

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