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ESG, Growing Pains, and Greenwashing

What happens when a new concept focused on finance becomes wildly popular among mainstream investors? A scramble to get into the game – which results in a good deal of confusion before everything gets ironed out.

Environmental, Social, and Governance (ESG) investment approaches are right in the middle of that process. Tremendous interest from investors (nearly half of those surveyed in 2020), vast inflows of capital, and a proliferation of products created a situation in which demand is dictating fast supply without the benefit of proven guardrails. Financial advisors have an obligation to stay attuned to their clients’ goals and to the most effective way to invest. It’s important to note that the question marks arising are a result of growing pains. Like so many industries and evolutions before this, the confusion will subside. Consider how automobiles disrupted the world, mobile communications, the internet: every significant advance requires a period of adjustment.

“Greenwashing” is the current form of chaos for ESG. Early-to-market investment products and ESG ratings agencies are constantly adjusting to the flow of information. No surprise, then, that Morningstar, one of the primary fund research platforms, pulled the ESG label from funds managing nearly $1 trillion in assets.

“The correction marks something of a line in the sand for an investment trend that has enjoyed stratospheric growth, much of which took place before regulations were in place…there are signs the industry is also capable of self-correcting. Before the 2021 introduction of Europe’s anti-greenwash rulebook — the Sustainable Finance Disclosure Regulation — asset managers in the region removed the ESG label from $2 trillion worth of funds, according to the Global Sustainable Investment Alliance (GSIA).”

The dialogue about greenwashing is critical for financial advisors to understand in order to discuss reliable options with clients interested in ESG. Truly knowing what clients are looking for is the first step to meeting their needs. The next step? Knowing what’s inside the investment that might fit those needs.

All this to say what we already know deep down: “trust but verify.” ESG ratings or fund labels on their own shouldn’t provide the only basis for investment selection. When advisors look under the hood to see how investments incorporate ESG, they can have informed conversations and make better decisions.

Simply put, the answer to greenwashing is due diligence – and that will likely never change. For more about the state of greenwashing and its impact, see our video Q&A with Max Messervy, U.S. Sustainable Investing lead at Mercer.

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