This Wednesday is Earth Day 2020, an ideal day for companies around the world to showcase their commitment to a greener future.
You may see some ads or press releases announcing corporate efforts to make supply chains more sustainable or major donations to environmental charities. You may also see some accusations of greenwashing—a company making a surface-level effort to look eco-friendly when its main operations tell a different story.
Responsible investors often tell us that they don’t want to buy companies that greenwash; they want the real thing. And they want investment managers who can tell the difference. But businesses are complex organisms, and sustainable business practices are rarely as simple as good versus bad. Our pointers can help steer you in the right direction.
Greenwashing at the company level
Corporate greenwashing isn’t always as clear-cut as, say, an oil company with a history of massive spills adopting a green-tinted logo shaped like the sun. Investors who are serious about keeping greenwashers out of their portfolio will want to be diligent about a company’s activities whether it’s making headlines or not. Reacting to negative press with branding, advertising, and media statements is one of the easiest ways for a company to present a more green picture of itself after a crisis. Unfortunately for them, it’s faster than ever for critics to counterreact thanks to social media.
We don’t advise relying on the company to provide the most comprehensive account of its own environmental practices—nor do we advise relying on Twitter. Instead, we recommend looking for information from company regulatory filings or disinterested sources such as legal proceedings, government agencies, nongovernmental organizations, and assessments from dedicated environmental, social, and governance (ESG) research providers.
One of the biggest misconceptions about such providers is that they work solely from company sustainability reports. This could hardly be further from the truth. Good research providers are staffed with hundreds of analysts who compile objective information about companies and make informed opinions about their behavior. In fact, in much of our own work, we don’t use research providers’ opinions at all; we use only the facts they assemble. This might include a company’s revenue streams, independently verified carbon footprint data, or a summary of the number and status of legal proceedings against the company and its responses.
In this case, the problem tends to be less of greenwashing and more of lack of information. There are limits to what companies can or will make publicly available and what third-party sources can turn up. But the amount and quality of information has exploded in the last five years. Newer revenue-based data sets now include issues such as private prisons, thermal coal, and palm oil. In other cases, data is becoming more complete with the addition of technological advancements to help turn up publicly available but less searchable information.
Subjective ESG ratings are the most obvious lightning rod for accusations of greenwashing. But these can be valuable as long as they’re used properly. In all the cases that we’ve seen, research providers make their methodologies and the basis of their opinions transparent to paying clients. Even if you disagree with their opinion, it’s relatively straightforward to understand how they arrived at it, and there may still be value in the information on which their opinion is based—not all that different from any sell-side research. This reflects the fact that even if investors agree on the facts of the matter, they can easily arrive at very different opinions about it. This shouldn’t be surprising; one can only buy a stock if someone else decides to sell it. Disagreement makes markets.
Greenwashing at the asset management level
The rise of ESG investing has resulted in added pressure on asset managers to prove their value to their clients. But no manager can guarantee a 100% green portfolio any more than they can guarantee big returns. More often we find that it’s less a matter of deception on the manager’s part than misunderstanding about intention. A manager who prioritizes labor practices over environmental practices may come across as disingenuous to investors who prefer the reverse—but this isn’t a straightforward case of greenwashing. Or a manager could prefer to hold environmental laggards and use shareholder rights to encourage them to do better. The carbon footprint of their portfolio may not be better than the benchmark, but they may actually be doing more to improve sustainable outcomes than managers who simply avoid these companies.
There are steps investors can take to make sure an ESG manager isn’t promising too much. Those looking to encourage companies to be better should examine managers’ active ownership practices, particular their proxy voting and shareholder engagement records. Investors looking to construct a portfolio aligned with their values should make sure their manager’s ethical criteria match their own. And those hoping for outperformance should look at their manager’s investment process.
Relative return improvement is no different when it comes to ESG. It requires a reliable process for identifying underpriced assets and realizing gains when those mispricings are corrected. This might not always align neatly with your ESG preferences, but it’s something all outperformance-seeking investors should take into account.
The bottom line
Every investor deserves an honest picture of where their money is going. That’s especially true for investors who are looking to make a return and take a stand at the same time. It’s equally important for these investors to be realistic about what their portfolio can achieve and to be confident that transparency and facts are the best tools at their disposal.