Week 40: Greenwashing, a weapon of mass destruction

In this issue: ▸ Do companies really want to fix the climate? ▸ Is it worth the fight? ▸ The problem(s) with green investing ▸ Despite the issues, Facebook is an ESG favorite ▸ And much more...

Dear all, 

The road to 2050 is paved with many questions.

Most of the questions we do have answers for. But some of our answers are both insufficient and also very convenient.

Here’s one such question: What is a good ESG investment?

Try answering that question for yourself before you read on.

The fact is that there’s no industry-wide consensus on what makes for a good or a bad ESG investment. It depends on your perspective.

The problem is that most investors have neither the time nor the inclination to dig into what it means to be a good or bad ESG investment, much less suss out to what extent a particular company or fund lives up to the ESG credentials it claims.

There are some simple truths in all of this. Investments always come first. An ESG fund still needs to deliver that return. We recognize the risk but see the money.

Do companies really want to fix the climate?

The people causing the climate problem have no direct incentive to fix it.

But they do have a very immediate desire to get the economy moving again after Covid-19, pay dividends to shareholders, help customers go about their day-to-day activities, and achieve their bonus targets.

The consequences for failing to account for ESG related risks associated with a loan, investment or asset, are still largely reputational, and companies continue to be benchmarked against one thing and one thing only, the profitability.

Has greenwashing become a weapon of mass destruction?

This question kept me staring out the window for a good part of the morning. 

Is it worth the fight?

I sort of wanted to stop here and say that’s all for this week, but I couldn’t.

There is this uncomfortable feeling in me. All those years of trying to do ESG for real with no B.S. were now staring at me. Looking me into my eyes, each and every one of those years. Staring in silence. Quietly.

Is all of this just for nothing? I kept repeating to myself that finance and sustainability need to work together. This is a two-way process. On the one hand, finance needs to recognise the risks associated with sustainability and needs to incorporate those risks into the investment process and portfolio allocation.

On the other hand, finance can help sustainability by, for example, channelling capital towards public and private investments that can address the climate change challenge.

It all sounds so clear and so constructive. But all the years kept looking at me in silence.

Some of those years were hard on me, and on the people close to me. Is it worth it? Someone asked me that question in an interview I did last week. Yes it is. 

But sometimes it is hard and brutal and very lonesome. And the impact is still not very visible…

Greenwashing – a weapon of mass destruction

For example, despite all the noise, the engagement efforts of asset managers has had no effect on greenhouse gas emissions over the past decade.

That’s one damning finding in research by Gianfranco Gianfrate, professor of finance at Edhec-Risk Institute, who has described greenwashing in the investment industry as a “weapon of mass destruction”, according to this article.

In a separate report, Edhec academics have also shown the inadequacies of current ‘sustainable’ investing. Only 12 percent of climate strategies are affecting companies’ carbon footprints, the one metric they must focus on forcing down.

In other words: 88 percent of climate investing strategies aren’t driven by carbon intensity.

The problem is exacerbated when other parts of the convoluted taxonomy of ESG factors is brought together. Just 7 percent of ESG funds have stock weightings affected by carbon intensity scores.

Gianfranco Gianfrate has been quoted saying: “Major [investment firms] are claiming to integrate sustainability into their stewardship and fund management, but they distract [end] investors, pretending they are doing what they are not doing.”

Engagement is one of the industry buzzwords the that professor focuses on:

“All top asset managers are doing some greenwashing. [They] want the largest possible universe of securities to invest in, so don’t like to divest but ‘engage’. Engagement is a perfect tool for procrastination.”

Engagement greenwashing is exacerbated by portfolio greenwashing, says the Edhec study.

The problem(s) with green investing

The Edhec study listed a number of other serious problems with green investing.

Climate investing strategies tend to focus on reducing the average carbon intensity across the portfolio. But individual companies that stop improving or even go backwards can be overlooked. More often than not, the ESG scores used leave a lot to be desired. And it is possible that some quite serious polluters can be owned without much threat of divestment.

Another problem stems from the focus on traditional benchmarks. Asset managers want their green strategies to not significantly underperform global stock markets, so they remain beholden to market capitalisation weightings. Climate investing may tilt away from these but not by enough to make a significant dent in the carbon intensity of what they are investing in.

Finally, the green investing that was touted as having outperformed in 2019 and 2020 arguably did so due to incidental factors. Most held stocks by ESG managers have consistently included names like Microsoft and Alphabet.

Therefore it can be suggested that market-beating returns came from overweighting low-carbon emitters in the technology sector, which happened to be driving much of world equity returns anyway.

Marketing slogans from asset managers like “doing good to do well” were something of a misnomer. Some supposedly green investing has been about doing nothing: the Edhec study draws attention to European climate strategies merely having to balance across broad categories of high and low carbon intensity sectors to meet EU regulatory standards.

Despite all its issues, Facebook is still an ESG favorite

There are many sad examples of how ESG scores does not filter out the real problems. Facebook is a good example. And when we zoom in on Facebook, we indeed find some of the convenient answers. 

Facebook’s platforms have been engineered to make users angrier and angrier to keep them engaged. They amplify thoughts of suicide among teens, and are used for sex trafficking. These are just a few of the conclusions of a recent series of investigative reports by the Wall Street Journal.

Headlines like this are nothing new for Facebook, of course. A 2019 investigation by the New York Times highlighted how gaps in oversight led to tens of millions of images of child pornography to run uncontrolled on Facebook Messenger.

Facebook was fined $5 billion that same year and forced to reorganize its corporate structure by the Federal Trade Commission (FTC) for use of deceptive practices to “undermine users’ privacy preferences.” The practices violated an earlier 2012 order by the FTC.

The new reports from WSJ beg a pretty big fat question for ESG funds: Why is Facebook among their top holdings?

Take the iShares ESG Aware exchange-traded fund (ESGU), which has more than $22 billion in assets under management. It counts Facebook in its top five holdings. The same is the case with the Vanguard ESG U.S. Stock fund (ESGV), with more than $5 billion in assets.

If the WSJ reports on Facebook are true (their reporting is amply backed by internal Facebook documents), ESG funds may need to step into the light and take some beating. 

If a company like Facebook target its product to minors while its own internal research show that it leads some teenage girls to commit suicide, how can that company possibly remain in an ESG fund?

If, after these revelations, Facebook is still owned by ESG funds, does ESG really mean anything? Isn’t it just a really effective marketing tactic?

And ESG funds keep growing…

By the second quarter of 2021, according to Morningstar data, U.S. ESG funds had more than $300 billion in assets, compared to just around $100 billion three years earlier.

Roughly 72% of investors, according to one Morningstar study, are at least interested in ESG or sustainability investing, with 44% either somewhat or very interested.

But are investors driving money into ESG funds because they, in a sense, want to do something to better the world, or are they doing so to mitigate investing risks?

For many, it’s the former. Almost 9-in-10 consumers think companies should be pursuing ESG practices, according to a PWC survey.

That’s good news. The problem is that ESG funds do not live up to its promise to investors.

They might do well, but are they really doing good?

Apple is not much better

This phenomenon extends well beyond Facebook. Apple is another company widely owned by ESG funds. If you don’t believe Facebook should be in an ESG fund, can you support inclusion of a company whose main device manufacturer, Foxconn, made its Chinese employees endure such miserable working conditions that some committed suicide?

Apple highlights the problems of ESG theory and practice: Not only did Apple run afoul of at least the spirit of ESG practices, but there wasn’t much investing downside. Apple has delivered 27% annual returns over the past decade, a remarkable achievement given  its gargantuan size. Despite its past issues and current issues Apple is top ESG-rated by many “ESG” providers. 

Yes, this can hurt, but a more sober answer is that our acceptance, silence, ignorance, complacency makes most of the ESG investments today a big joke.

We can choose a different path and we have that privilege. We can do this much better and still make returns.

Here you can read my ESG analysis of Facebook, which I published last year:

"How sustainable is Facebook?"

Are climate funds aligned with Paris?

Let’s continue down the same path and look more specifically at the smoking mirrors of ESG and climate themed funds with regards to the Paris Agreement targets.

In a study by InfluenceMap, some 71 percent of the 593 ESG funds studied failed a test to determine whether or not they were aligned with the Paris Agreement’s global targets.

Worryingly, 55 percent of the 130 specifically “climate-themed” funds reviewed also landed negative Paris alignment scores. Several allegedly sustainable funds continued to hold fossil fuel production value-chain companies, including some funds labelled “fossil fuel restricted“.

Overall, the study criticised the lack of consistency and poor transparency of many ESG and climate-themed funds and noted a very large variation of impact among these instruments.

OECD: ESG investing is toothless at fighting climate change

It’s not only Edhec and InfluenceMap that have serious doubts about what is going on. Now, OECD has has also issued a strong criticism of ESG investing.

OECD, the organisation representing the world’s richest countries, has slammed ESG investing for being toothless at fighting climate change. In a report, OECD hit out at ESG investing for lacking “clarity” and “transparency”.

Data inconsistencies, lack of comparability of ESG criteria and rating methodologies, as well as inadequate clarity over how ESG integration affects asset allocation reduce the impact green investing can have on tackling climate change, the report said.

Finally, if you wonder what the global ESG regulation landscape looks like, you can find it here. This report is very easy to read and gives some good insights.

That’s all for now. 2021 is staring me down, and I’m on my way out for a walk. 

Kind regards,
Sasja