Just how green is ESG investing?

Environmental, social and governance investing may be a burgeoning global business but do investors really know how green their investments are?

Just how green is ESG investing?
3 minutes

Borderline stocks

Much to Shaw’s surprise, she found a number of the funds that were part of Courtiers’ ethical strategy were a lighter green than she had expected, and that some were permitting borderline stocks into their portfolios.

There is nothing surprising about funds that drift from a tough, exclusionary stance to a more flexible ESG outlook. Changes in fund managers, markets or demand could all influence such a move. The problem is that the vast majority of Shaw’s clients prefer the dark-green approach and might be shocked to learn where their money is going.

For instance, after inspection Shaw noticed one portfolio had Amazon among its holdings. Given the recent criticisms of the treatment of its warehouse employees, particularly in the UK, she felt it was a questionable constituent of an ‘ethical’ portfolio.

“These may not be defined as human rights abuses per se, but there were certainly issues with Amazon’s employee practices, and it just felt too close to the bone for us. There are so many stocks out there. Why do we need Amazon when we have a global universe of stocks to draw from?”

Equally problematic is the fact that many ‘ethical’ managers are also running ‘non-ethical’ mandates as well. “This is obviously acceptable,” says Shaw, “but it does mean that such fund managers are governed by the strictness of the mandate only, and may push the boundaries of that mandate as far as they can be pushed in order to obtain performance within the peer group.” 

During a review of its ethical bond and equity model portfolios, Courtiers noticed one of the funds in which it was invested, F&C Responsible UK Income, briefly held shares in Shell following its merger with BG Group in February.

Although the global version of the fund – F&C Responsible Global Equity – sold its shares in BG prior to the merger with Shell, it seems the UK fund had taken shares in the oil giant into the portfolio and retained some of that position until the summer.

While this was acceptable as far as the fund’s mandate was concerned, Shaw says some investors may not have appreciated the fact they were temporarily investing in a portfolio containing Shell.

Morningstar senior analyst Muna Abu-Habsa argues that “the industry has moved on from this type of negative screening approach”. Instead of shades of green, Abu-Habsa says it is more helpful to break ethical investing down by objective, which creates two distinct types of funds: ‘values-based’ versus ‘value-based’.

She says the former is synonymous with SRI, a more traditional values-based approach that makes use of the exclusionary screening to curb exposure to ‘sinful’ products or industries.   

The latter methodology falls under the ESG umbrella and focuses more on the long-term sustainability of companies and the choices they make. 

In collaboration with investment research company Sustainalytics, Morningstar’s Sustainability Rating evaluates portfolios based on the sustainability profile of their holdings and measures this against the performance of peers in the same category.

The final portfolio scores also reflect penalties for controversial incidents in a company’s history. Sustainalytics factors these into its original company ratings and Morningstar applies an additional deduction during its portfolio evaluation to emphasise the importance of disclosing things such as accounting or emission scandals to investors.  

Abu-Habsa stresses it is important to consider environmental, social and governance issues in tandem in order to protect against undue risks. 

She says: “Investors should remember that controversy can happen to any company, it is not confined to a sustainable or unsustainable one. Volkswagen had a good environmental and social score but a very poor governance score.

“If you are an investor who is purely focused on the environmental element, you may have gone for the stock because it has sustainable practices, but by ignoring the red flags on the governance side of things, you would have been exposing your investors to a different set of risks.”

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