Understanding greenwashing and why it matters

Creating a legacy for your children, grandchildren and generations to come takes lots of foresight and planning. It also means investing in companies that are working toward a sustainable future. Unfortunately, because ESG investing has become a buzzword, greenwashing has become more prevalent. 

Investopedia defines greenwashing as “making an unsubstantiated claim to deceive consumers into believing that a company’s products are environmentally friendly or have a greater positive environmental impact than they actually do.”

Morningstar categorizes 627 mutual funds or exchange-traded funds as being ESG (environmental, social and governance) or sustainably focused. That’s a lot of funds with a lot of different and diverging definitions of what sustainable, responsible and impact investing (SRI) means.

And while I truly believe in diversity of opinion, I still have a hard time understanding how some managers can include companies such as ExxonMobil or McDonald’s in their SRI portfolios.

Regardless of your beliefs or what types of companies you’re interested in investing in, it’s critical to do your research to avoid greenwashing. A term from my high school Latin class is appropriate here: ‘caveat emptor’ — or buyer beware.

DEFINING ESG AND SRI

First, it's important to understand the difference between ESG investing and sustainable investing, because both investment managers and the media often equate the two.

ESG is simply a set of metrics quantifying the environmental, social and governance risks within a company. Many investment managers then use that data to adjust allocations of traditional indexes, thereby reducing a portfolio's “ESG risk.”

Sustainable investing is more intentional. The investment process analyzes which sectors, industries and companies are and will be leaders in a new, cleaner and more sustainable economy. Which technologies will make society healthier and more resilient? How can we reduce emissions and transition to renewable energy while at the same time keeping in mind the importance of equity issues?

Sustainable investing represents a step beyond ESG investing by being solutions-based and focusing on innovation. At the end of the day, I would define the practice as true growth investing.

The example I typically use to delineate the two types of investing is this: An ESG portfolio that reduces its exposure to ExxonMobil is “less bad.” A portfolio that eliminates the company entirely is better. But a portfolio that replaces ExxonMobil with First Solar is truly sustainable.

Most of the 627 ESG funds listed by Morningstar are likely “less bad” and a function of investment managers' focus on indexing. The easiest way to integrate ESG metrics into a portfolio is simply layering them onto an existing index. It’s also cheaper.

But as with most things, cheaper isn’t always better. It takes effort to create a portfolio from scratch; to understand issues such as climate change, resource scarcity and equity; and to find innovative companies leading us into the new economy.

COMBATING GREENWASHING

In my experience, responsible investors want solutions-based portfolios, not “less bad” ESG indexes. And large fund managers are, at their core, institutional investors, and they invest for individual investors in the same way that they would invest for themselves.

The solution for individual investors is multifold. Before selecting a fund manager, ask a lot of questions, including how much experience the manager has in responsible investing. Does this person understand the differences between ESG and sustainable investing? What types of companies and industries is the manager investing in? And how does the manager plan to avoid the “less bad” portfolios? 

If you already have a fund manager or family office, make sure the manager understands your goals. Create a family mission or motto to ensure that your investments are aligned with what you’re looking to achieve. Make sure to have regular meetings to ensure you are in sync and your team is adjusting your investments accordingly based on new developments and changes in technology and information available.

Ensure you also have conversations with your family so they understand your goals and the importance of avoiding greenwashed funds.

Consider separately managed accounts (SMAs) instead of mutual funds or ETFs. SMAs own individual securities in your account and make it much easier for the investment manager to focus on solutions instead of indexes.

Finally, don’t be afraid to switch to an adviser who is an expert in sustainable investing. Because responsible investing isn’t one-size-fits-all, an expert can understand which values are important to you and guide you through the greenwashing maze. 

An expert also will help you navigate the negative political rhetoric that currently plagues ESG so you can be comfortable with your decision. Remember that ESG is simply a set of numbers. It’s risk metrics. And when used well, it can help you create a sustainable portfolio that can have a positive impact on the world, and your family, for generations to come.