Greenwashing: Responsible Investing Regulators Target

Greenwashing is a problem that regulators of responsible investing are trying to solve.
Questions about ESG investing are very important. In recent years, there has been a lot of buzz about responsible investing, which gave investment managers a reason to create ESG funds or change their existing portfolios into ESG-friendly versions. Issuers also spoke up to talk about the ESG benefits of their bonds. There were, of course, many honest managers and issuers. But it was easy for some managers to talk about “ESG integration,” which was a vague term. And it was just as easy to lie about someone’s skills and qualifications.

Now, no longer. Since 2021, there have been a lot more rules meant to stop “greenwashing” and help people find their way through an investment product market that is getting more complicated. It can be hard for managers to meet the different reporting and disclosure rules of different regions and countries. But at the end of the day, all of these rules are meant to help asset managers do what they say they’re going to do and be completely honest about it.

That means they must be clear about their ESG goals, make and share rigorous, reliable investment frameworks that support those goals, and give clients a full report on how they are doing in meeting those goals.
All parties involved must speak the same language.

Because there are more rules and investors are more aware of them, clear definitions and full disclosure are required. Asset owners and managers need to work with regulators and policymakers to make ESG integration and other responsible investing practises clearer and less confusing.

First, we need to tell the difference between strategies that include ESG and those that focus on ESG. To integrate ESG, you have to figure out which ESG issues are financially important, then do research and figure out how they affect business and financial measures like revenues, margins, cash flows, valuations, and the cost of capital. Then, investors must decide if the issuer’s value takes into account the risks and opportunities that come with it.

ESG-focused strategies go beyond ESG integration. They have specific ESG objectives or themes, such as focusing on issuers whose ESG practises are improving or investing in companies that are developing climate solutions. They also try to maximise risk and return. Regulators want to put all of the different ESG-focused strategies, like exclusion, best-of-breed tilting, thematic investing, sustainable investing, and impact investing, into a common taxonomy.

Investors who want portfolios that include ESG factors should know how this is done. We think that ESG-integrated portfolios should be very clear about how ESG issues are taken into account at each step of the investment process where they apply. For strategies that include ESG, investment teams may start by figuring out and evaluating the most important ESG risks and opportunities. This can help them come up with ideas for investments. Then, analysts should be given tools, data, and research from third parties and their own companies that help them learn more about the ESG risks and opportunities of an issuer, sector, or portfolio.

To do this well, portfolio teams must be deeply involved in the ESG issues that will shape the future of our world from many different angles. Analysts should talk about ESG issues with the heads of both public and private companies and non-profits on a regular basis. Based on what they learned at these meetings, investment teams should consider environmental, social, and governance (ESG) factors when making investment decisions.

They can do this by changing cash flow discount rates, credit rating forecasts, or other relevant metrics. And real ESG integration doesn’t end when a decision is made about an investment.

Managers should keep an eye on issuers and work with regulators and policymakers to clarify what ESG integration means.

Getting Past the Arguments
This more thorough look at possible investment risks and returns gives a manager a clearer picture of how security will affect their finances. Integrating environmental, social, and governance (ESG) factors into the investment process is, at its core, about improving risk assessment in the hopes of getting better risk-adjusted returns.

For example, if a portfolio wants to invest in an industrial company whose factories put out a lot of carbon, what will that mean for the business and the return to investors? The investment team must do research and think about how possible carbon taxes or pollution regulations might affect the company’s future capital expenditure needs or how a competitor making a lower-carbon alternative might affect the company’s market share.

ESG integration is just better investing, in our view. Few investors, though, would be against ESG-integrated strategies, but not everyone wants ESG-focused strategies.

And just like investors don’t have to own every style box, they don’t have to own every segment of the ESG-focused investment spectrum.

Diverse ESG return streams will be in higher demand.
Investors who are thinking about ESG-focused strategies want to make sure that they won’t lose the chance to make money. In fact, the link between ESG investing and making alpha has been short and spotty in the past.
In recent years, ESG-themed portfolios have done better than the market as a whole, especially since many of them have a lot of large-cap growth stocks. But in 2022, when tech stocks fell and fossil fuels went up, many ESG portfolios did not do as well as they could have.

This makes us think that we need to make ESG strategies that work together and don’t rely on a single source of beta. As with any asset allocation, investors should think about a variety of equity styles, alternatives, and fixed income to spread out ESG-focused return streams. Also, investors shouldn’t only be able to put their money into companies since sovereign debt, real assets, and assets that have been securitized can also be used to move ESG levers.

What to do next as responsible investing grows up
Responsible investing may have had a rough year, but it’s not going away. On the other hand, investors will need more guidance and clarity around these growing pains because net zero commitments are expected to drive fast growth in ESG assets and shareholder activism around ESG is expected to rise.

Even though regulations, consumer preferences, and the competitive landscape are always changing, asset managers must keep having productive conversations about ideas that are central to responsible investing. These ideas include regulations, a common language, strong frameworks, different return streams, and more.

From climate change to forced labour to discrimination and diversity, ESG factors are important investment risks and opportunities that can stop or help create long-term shareholder value. Because of this, we think that the best way to deal with ESG challenges and ensure the long-term success of our clients is to take a careful, financially-based approach to investing.