As more and more people want to invest in companies that are environmentally friendly and socially responsible, there are concerns about "greenwashing." This is when companies pretend to be good for the environment, but they can't prove it. In one survey, greenwashing is now seen as a bigger problem than financial performance when it comes to investing in sustainable companies.
The securities regulators have become aware of the danger that greenwashing poses to investors. They have warned financial advisors and fund managers to be careful and not let investors be misled. They have also given advice on how to avoid greenwashing, such as making sure the fund manager actually follows their stated goals for being environmentally and socially responsible.
Greenwashing is a problem because it takes away money from companies that are actually doing good for the environment and instead gives it to companies that are not as good. This makes it difficult for investors to invest in a way that matches their values.
However, despite more attention being paid to greenwashing, it still happens. Wealth managers need to realize that they are part of the problem and take action to avoid it.
Why it's Hard for Advisors to Avoid Greenwashing
It takes a lot of time and effort to make sure a company is truly environmentally and socially responsible. Some advisors try to identify red flags, like investing in companies that are involved in mining. But this is not enough. For example, a mining company might have a high rating for being environmentally responsible compared to other mining companies, but that doesn't mean it is actually doing a good job.
Advisors can't just rely on third-party ratings either, because these ratings often disagree with each other. There is no one definition of what it means to be environmentally and socially responsible, so it's hard to know if a company is really following these principles or if it's just pretending.
Advisors also need to be careful of funds that have a high rating but no clear strategy for being environmentally and socially responsible. The rating can change over time as the holdings of the fund change.
Lastly, some ESG ratings don't consider shareholder engagement and proxy voting, which are important ways that companies can make a positive impact.
What Advisors Need to Do
To avoid greenwashing, advisors need to do two things. First, they need to look at the holdings of a fund to make sure it is actually following its stated goals for being environmentally and socially responsible. For example, a "Fossil Fuel Free" fund should not invest in companies that make fossil fuels.
Second, they need to evaluate a fund's strategy for being environmentally and socially responsible. This means looking beyond just the current rating and making sure the fund is truly committed to these principles.
Some advisors are already doing these things, but just seeing the words "ESG" or "sustainable" in a prospectus does not guarantee that the company is truly committed to these principles. Advisors need to do their research and make sure they are investing in companies that are actually making a positive impact.
Adapted from source: Krosinsky, Cary and Gabe Rissman. "How Wealth Managers Can Remove the Greenwashed Wool Over Their Eyes." RIA Intel, www.riaintel.com/article/2aucukqyi44iagaehko3k/opinion/how-wealth-managers-can-remove-the-greenwashed-wool-over-their-eyes.