Would you like to invest in ESG funds?Check your disclosures for greenwashing risks

As awareness of the impact of human behavior on the environment increases, attention has focused on the role that companies play in society and how they operate. Conscientious investors want to invest in companies that help sustain the environment, rather than harm it.

To this end, investors are keen to allocate their money to funds whose investment managers demonstrate a sense of responsibility regarding the portfolio choices made. But there were problems with the way some investment funds were run, including how they named their so-called environmental and social governance (ESG) schemes and how they marketed them to clients. One way this problematic behavior manifests itself is “greenwashing.”

Greenwashing in investment funds

Greenwashing is the act of misrepresenting or making false or misleading statements about the environmental benefits of a product or service provided by a company. There is always a danger that investment funds will promote themselves as “environmental champions” without changing much in the way they invest.

In a report published in September 2023 titled “Exploring Greenwashing Risks in Investment Fund Disclosures: An Investor Perspective,” the CFA Institute states that understanding the sustainability characteristics of a fund He emphasized that it can be difficult due to a number of issues. These issues include inconsistent disclosures, omissions of important information about sustainability goals and strategies, unsubstantiated claims, and potentially overstating the characteristics of actual sustainability. This includes undue emphasis on certain features.

The report found:

a) ESG-related information may confuse investors and give the impression of greenwashing.

b) Greenwashing is difficult to uncover based on documentation alone; analysis requires judgment

c) The context-specific nature of greenwashing makes it difficult for investors to clearly understand how ESG factors are integrated into the investment process and investment fund objectives.

Strong regulatory involvement

Regulators around the world are currently grappling with this issue. In the United States, for example, the Securities and Exchange Commission is proposing rules to strengthen disclosures about ESG investment practices by investment advisers and investment companies.

The Commission’s efforts to improve the quality and consistency of ESG-related disclosures from investment companies were a step in the right direction to ensure that investors are not misled by false and exaggerated claims.

In India, this issue is being addressed by regulators at two levels. Companies are required to disclose BRSR (Business Responsibility and Sustainability Reporting) for the top 1,000 companies by market capitalization. Securities and Exchange Board of India (SEBI) has also updated its BRSR reporting format. BRSR is a standardized format for a company to report its performance on his ESG parameters.

In July 2023, SEBI notified rules for a new category of mutual fund schemes for ESG investments and related disclosures. Regulatory disclosure requirements for ESG schemes are as follows:

a) Mutual funds shall clearly disclose the name of the ESG strategy on the ESG fund label.

b) Mutual Funds shall disclose in their monthly portfolio reports the BRSR Core Score (BRSR Core is a subset of BRSR) and the name of the ESE rating provider providing the ESG scheme scores for the security.

There are also changes planned as companies work to provide assurance about the validity of BRSR data. For example, ESG schemes require investing only in companies that fully comply with BRSR disclosure standards. However, from October 1, ESG schemes will also require companies to invest at least 65% of their assets under management in companies with comprehensive BRSR and BRSR Core disclosures.

Investor burden

There are numerous examples of confusing, ambiguous, and incomplete disclosures related to green funds’ names, their goals, criteria, and impact claims. Greenwashing is a complex issue with several layers.

Therefore, in addition to regulatory changes, investment managers will need to perform thorough, structured due diligence to ensure that a fund’s sustainability credentials are fairly represented.

From an investor’s perspective, investment selection is a subjective and personal decision based on personal preferences. The world faces myriad challenges today, including climate change, social and economic inequality, and global economic uncertainty and instability. Broadly speaking, given these challenges and the need for accurate information that is free from misrepresentation, it is a good idea for investors to become more aware of the various avenues available to them for responsible investing.

When investors are better informed about ESG-based investment portfolios, the quality of their decisions will improve. Therefore, it is important to look beyond the label and evaluate an ESG fund’s investment philosophy and portfolio construction. You should also consider your disclosure standards to assess whether you are satisfied with the information your ESG fund discloses and whether it is consistent with your goals.