ESG offers the chance of a fantastic rebranding for an unpopular [financial] industry, an excuse to  crunch a lot of data and then charge for it, a great opportunity to bid for the huge pools of money held on behalf of public sector workers and charitable organizations … and most of all an opportunity for active management to justify its existence. John Authers in the Financial Times

Just a few years ago the number of investors whose objectives included anything other than maximizing risk-adjusted returns was very small. Responsible investing (“RI”) was a niche idea, engaged in mainly by religious groups and cranks. (Okay, I exaggerate – slightly.)

But almost overnight, it seems, the desire to invest responsibly – that is, to make the world a better place as well as to make money – has gone mainstream. Many of the world’s largest pools of capital, from sovereign wealth funds to large endowments and foundations to wealthy families have adopted some form of responsible investing.

Late last year, for example, over 400 investors controlling $32 trillion of assets called on governments to combat climate change, and there are now more than 400 sustainable funds in the US that, in the aggregate, invest almost $90 billion. Globally, there are more than 3,000 RI funds available, investing $1.2 trillion.

This revolution has been propelled by millennials, women, and also by the now widely accepted notion that investing responsibly, if properly done, need not harm returns or increase risk.

For the purposes of this series of blog posts I will assume that you have already decided to invest responsibly, whatever that means to you, but that you simply don’t want to be taken advantage of.

First, though, some definitions. In the literature, responsible investing goes by many different names: socially responsible investing (SRI), environmental, social and governance investing (ESG), impact investing, ethical investing, mission-related investing, and so on. There are important differences among these various approaches, but for purposes of this series of posts, the term “responsible investing” will encompass all of them unless otherwise noted.

Let’s begin by looking at two huge problems RI investors face right out of the box: an aggressive (that’s a polite word for it) financial industry, and the phenomenon of “greenwashing.”

Be aware of the financial industry’s poor track record for dealing fairly

The main threat to RI is the very success of the idea itself. There are now so many investors, and so much capital, looking for RI investments that the usual financial industry fraudsters and ethically-challenged salespeople have come out in force.

As long as there have been investors – that is, for thousands of years – there have been people looking to take advantage of them. Historically, investors have been sitting ducks for these nefarious operators because we are (a) ignorant, and (b) greedy. By “ignorant,” by the way, I mean that investors tend to be far less knowledgeable about investing than are the people who are selling them the investments.

Today’s RI investors are a somewhat different breed, but they have analogous vulnerabilities. Instead of being greedy, RI investors tend to be extremely emotionally invested in their desire to improve the world, and it is that emotionalism that the financial industry preys on.

RI investors may be no better at controlling their passion than more traditional investors are at controlling their greed, but RI investors can do something about their ignorance. Hence this series of blog posts.

Beware “greenwashing”

Greenwashing derives from the word “whitewashing,” which means covering up bad behavior with misleading information.

Rumor has it that the word arose in the hotel industry when hotels would ask guests to re-use their towels, supposedly to improve the environment but actually to save the hotels money on laundry costs. (If the hotels were actually interested in the environment, they would reduce customers’ bills by the amount the hotel saved.)

Greenwashing has become so widespread all over the world that many environmentalists now prefer the term “ecoporn.” A now-dated study from 2010 by the Terra Choice Group, for example, concluded that more than 95% of products claiming to be “green” weren’t green at all. I suspect the percentage would be even higher today.

Greenwashing is extremely widespread in the RI space. In the investment world salespeople might slap a “green” or “ESG” label on an already existing product that was developed without any thought to RI, but which happens, by accident, not to exhibit too many objectionable characteristics. But after you buy the product, all sorts of objectionable characteristics can crop up, since the product isn’t really an ESG product at all.

Here are some other examples of greenwashing:

A firm is offering a genuinely ESG product, but the firm has no experience or track record in the RI space and appears merely to be jumping on the RI bandwagon.

A passive index manager purports to follow ESH principles, but in fact, in order to avoid unacceptable tracking error, includes many questionable companies.

A socially responsible fund whose top ten holdings include Shell Oil and miner Rio Tinto.

A sustainable “engagement equity” fund invests in a highly pollutive mine in Africa because, in the words of the fund manager, “a great big mine that employs people is good news for the local economy.”

Investments pitched as RI but which are really nothing more than schemes to capture government subsidies and then sell the projects to “greater fools.” (E.g., the early “greentech” investments.)

I could go on and on, but to avoid being tripped up by greenwashed products, RI investors need to cut through the green marketing hype and consider, instead, whether (a) the manager has any experience in the RI space, (b) whether the manager and its product actually integrate RI into the core of the investment process, and (c) whether the manager actually has the skills to do so.

Next week we’ll look beyond greenwashing to see what other traps await unsuspecting RI investors.

Next up: Responsible Investing Without the Hype, Part 2

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Please note that this post is intended to provide interested persons with an insight on the capital markets and other matters and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.

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