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Is the fund firm that’s promised to help you save the world and line your retirement nest lying to you?
Malicious or not — loose regulations and uneven reporting make intent hard to enforce — the firms that are building portfolios with stocks, mutual funds and exchange-traded funds under the banner of Environmental, Social and Governance, or ESG, may have a language issue.
The University of California, San Diego, and the nonprofit sustainable-investing advocacy group As You Sow concluded that the linguistic patterns found in mutual fund and ETF prospectus language they reviewed has a relatively low correlation with its ESG rating. The collaborating teams spent four months analyzing 94 mutual funds and ETFs with “ESG” in their name.
“We see funds with ESG in their names getting F’s on our screening tools because they hold dozens of fossil fuel-extraction companies and coal-fired utilities,” said As You Sow CEO Andrew Behar.
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Their report indicated that investors may not be able to tell the difference between a prospectus for true ESG as opposed to so-called greenwashing mutual funds and ETFs.
“Linguistic patterns found in mutual fund and ETF prospectus language has a relatively low correlation with its ESG rating.”
For instance, currently there are many “fossil-free” fund claims with significant investments in traditional oil
CL00,
and gas
NG00,
companies, the researchers said.
One reason might be that a fund is operating under a “low-carbon transition” theme, by which even big energy firms ExxonMobil
XOM,
Chevron
CVX,
and others, as well as fossil-fired utilities like Duke Energy
DUK,
and Southern Co.
SO,
have diversified their business lines into solar, wind and other renewables. Still, the “transition” timeline is often a moving target, and as of now, unenforceable. Most operate true to their main profit centers of pumping oil and gas, or powering the U.S. electric grid with natural gas or coal, whichever is more cost-competitive as markets go up and down.
Related: Chevron deepens carbon-capture push with Microsoft, Schlumberger linkage
Such portfolio diversity can happen when funds are operating under more than one mandate: “growth” and “ESG,” for example. In that regard, tech shares have historically padded returns for otherwise mostly ESG funds. Others taking an arm’s length view of “sustainable” investing have argued that shareholder activism and ownership is what will nudge the “cleaner” transition along, not ignoring these stocks altogether.
Read: The ‘dirty’ U.S. economy bounced back faster than overall growth last year — here’s how
What’s in a word?
The As You Sow and UC San Diego research teams explained their methodology here, but in essence they combed prospectuses for words such as “carbon,” “weapons” or “labor.” The analysis also looked at “wiggle terms” that are often found in prospectus language to make the ESG terms less precise: they include “may consider,” “believe, and “possibly,” among others.
As You Sow said it approached the university team after noticing that of the 3,000 mutual funds and ETFs in the nonprofit’s online Invest Your Values scorecard, 94 had “ESG” in their names — yet 60 of these earned a “D” or an “F” on one or more ESG criteria. That scorecard flags companies in funds along seven areas: fossil fuels, deforestation, gender equality, civilian firearms, prison industrial complex, military weapons and tobacco.
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Much is left open to investor interpretation. Investors who are already contemplating risk tolerance, diversification and other factors. Plus, showy returns may allow some investors to forgive the labeling, at least for now.
ESG had a standout year in 2021. For instance, the $867 million Xtrackers S&P 500 ESG ETF
SNPE,
and the $450 million SPDR S&P 500 ESG ETF
EFIV,
gained 31.4% and 31.3%, respectively.
Read: ESG ETFs Had a Winning 2021—but CFRA’s Todd Rosenbluth Says Be Selective
Major influencers
The investment community, particularly the arm that’s supporting socially-conscious and environmentally sound stocks, funds and ETFs, have increasingly been torn between cheering on the nascent growth of green technology or alternative energy companies as a way to get in early in the fight to slow global warming and push greater representation on corporate boards, all the while demanding that these types of investments stay true to purpose and churn up positive returns.
BlackRock
BLK,
the world’s largest fund manager with $9 trillion in assets under management, has made a big show of its call for corporate climate disclosures, including at the Big Oil firms it still funds, and in declaring climate change the investing opportunity of a lifetime.
Back in 2019, BlackRock and CEO Larry Fink declared their intention to increase ESG investments more than tenfold from $90 billion to a trillion dollars in the span of a decade.
“‘It’s a very supportive discussion, but it is also a challenging discussion because we want to be with these companies for decades.’”
Sustainable-investing advocates embrace BlackRock’s heft when it comes to ESG, but have been critical of what they argue is a barge-like turn for the fund giant.
“The science on climate change has been crystal clear for many years … yet the world’s largest asset manager, with remarkable resources, has only started taking tangible action in the last year,” Peter Uhlenbruch, head of investor standards at ShareAction, an investor activist group, told S&P Global last year.
Sandy Boss, the global head of investment stewardship for BlackRock, said at a Bipartisan Policy Center event last February that the asset manager is doing more to engage with companies on climate change issues.
“It’s a very supportive discussion, but it is also a challenging discussion because we want to be with these companies for decades,” Boss said. “We’re increasingly seeing the sustainability and the climate change shift in investing really accelerate. We’ve all seen when capital markets move, they can move incredibly fast.”
Universal Owner, which issues reports using cost-benefit models for carbon intensity and other information it believes investors should have, has called out fund firm Vanguard, the world’s second-largest asset manager, saying it leverages climate branding through joining the Net Zero Asset Managers Initiative but continues to invest its beneficiaries’ capital in “damaging” fossil-fuel companies. Vanguard did reply to a request for comment by the end of business Tuesday.
Opinion: Don’t let perfect get in the way of good enough when it comes to ESG investing
“‘The problem is that there is no truth in labeling.’”
The ESG “greenwashing” report’s findings also encouraged a call to action. The investment world — regulators such as the Securities and Exchange Commission, in particular — should create a universal glossary and enforce such language when it comes to enticing would-be investors to the ESG space, the writers noted.
“The intent of this study is to underscore the necessity for the creation of a common glossary of terms and fund classifications subject to [Securities and Exchange Commission] enforcement,” said As You Sow’s Behar. “This will help to eliminate confusion and misleading marketing, fund naming and prospectus language.”
The teams took their findings to the SEC, which is considering tighter regulation on how publicly traded companies calculate and report climate-change risk such as eroding shores or higher insurance premiums for their shareholders. The SEC is also reviewing how funds and ETF firms sell their ESG philosophies.
“The problem is that there is no truth in labeling. If these funds were groceries, then a jar labeled ‘peanut free’ may contain 19% peanuts and people with a nut allergy would end up in the hospital,” Behar said. “When investors put their hard-earned money into an ‘ESG’ or ‘fossil free’ fund they expect to reduce their climate risk and not own big oil, coal and deforestation.”
