Leadership Perspectives | 08.04.21
One More Bell to Answer – How Green Is That Fund?
Advisors have one more red flag for which they are obliged to keep an eye; or, rather, a green one.
Soaring interest in funds pegged to "environmental, social and governance" (ESG) considerations—also called "socially responsible," "sustainable," or "responsible" investments—has given rise to growing concerns about the possibility of misleading claims.
Regulators have put the industry on notice: money managers may be prone to misleading shareholders over their products' underlying holdings, portraying them as, say, more environmentally friendly than they actually are.
It's a practice known as "greenwashing"—and it is coming under scrutiny.
SEC Considering New Rules
Last month, U.S. Securities and Exchange Commission Chairman Gary Gensler said the agency is considering rules to require ESG fund managers to disclose the criteria and underlying data used to support the label.
Some baseline categorical guidelines would be welcomed, said James Katz, CEO of Humankind Investments, which runs an exchange-traded fund connected with companies that Humankind, via its own scoring system, deems most earth-friendly.
"The SEC has had a lot of success promoting transparency and accountability," Katz told InvestmentNews.
If they provided a series of labels that people can choose from, and furnish the definitions, then that could be a starting point with respect to tackling the nebulous task of choosing precise terms for even talking generally yet consistently about what social responsibility means, which can be difficult, he explained.
"Categorization would be helpful for investors to understand what's going on," Katz said.
Getting On The Greenwagon
So here’s a recap. The pandemic—plus scarily more frequent once-every-1,000-years weather events—seems to have shocked investors into seeking out more sustainable investment products, which has propelled asset managers into marketing overdrive.
The Board of the International Organization of Securities Commissions (IOSCO), comprising regulators from the U.S., Europe, and Asia, recently said that some asset managers, in their haste to promote green credentials, may misleadingly label products as sustainable without carrying out "any meaningful changes in the underlying investment strategies or shareholder practices," the IOSCO said, advocating stricter approaches for preventing asset managers from overstating the climate-friendly credentials of their products to investors.
Regulators worry about the lack of reliability and comparability of ESG data asset managers disclose.
Follow the Money
A record $51 billion flowed into sustainable U.S. funds last year, according to Morningstar.
And such funds attracted an all-time record level of fund flows in the first quarter of 2021.
In the first three months of 2021, per Morningstar, funds in its sustainable category saw nearly $21.5 billion in net inflows, exceeding the previous record for a quarterly inflow ($20.5 billion in the fourth quarter of 2020). Q1’s $21.5 billion in inflows was more than double the $10.4 billion seen in the first quarter of 2020. And it was about five times greater than Q1 flows in 2019.
The Madrid-based IOSCO threw down supervisory expectations on June 30 with the release of its IOSCO Consultation Report on Recommendations for Sustainability-Related Practices, Policies, Procedures and Disclosure in Asset Management.
In it are recommendations covering: asset manager practices, policies, procedures, and disclosure; product disclosure; supervision and enforcement; terminology, and investor education.
The IOSCO is now requesting feedback.
Within one week of the report's publication, SEC Chairman Gary Gensler told the agency's Asset Management Advisory Committee that new potential fund rules are under consideration and would complement new public company climate change risk disclosure requirements that the agency plans to propose in October. New rules, were they to be proposed, would also aim to stamp out misleading product promotion while establishing standardized language around sustainable investing.
"In investing, funds often disclose objective metrics," Gensler said, according to Reuters. "When it comes to sustainability-related investing, though, there's currently a huge range of what asset managers might mean by certain terms or what criteria they use."
Issues that investors might raise with their advisors when discussing a fund labeled as ESG might include a general, open-ended query ("what gives them the right to make that claim?") to more nuanced, deeper dive examinations of all of the other funds a manager has under its umbrella, such as ones that do not make a ESG claim, and whether these product offerings run counter; or there could be a client or prospect keen to examine a mutual fund’s holdings, scouring for that one company in the portfolio that, sure, might own some wind turbine investments…but look here do they not also have significant exposure to come coal-fired power plants as well?
Advisors screening for ETFs may at a minimum want to gravitate toward products that have been around for several years versus ones that just launched more recently.
ETF Global, a New York-based analytics firm, tracks 144 ESG-based ETFs, 92 of which were launched prior to the start of 2020.
Driving the labels that ETFG uses are funds' investment objectives and security selection processes that they set forth in their ETF prospectuses, ETFG analyst James Budd said.
"We developed a proprietary taxonomy using a multi-level hierarchy," Budd said. "That allows for direct comparison and distinction among a broad variety of attributes, exposures, peer groups, and strategies."
To win over younger, more socially-minded clients, advisors would be well served to do extra due diligence in terms of poking around at the types of scoring metrics any given money manager purports to employ, so as to ascertain, on a granular level: are they utilizing proprietary in-house screens? Or just relying on one outsourced provider and how reliable is that provider?