As the world gears up for the 26th UN Climate Change Conference (COP26) this year, never before has more scrutiny been paid to the substance of sustainable investment products. Rightly so, I might add, if we are to salvage our last hopes of evading catastrophic and irreversible climate change. But what of the substance of these critiques? Are the hordes of naysayers really onto something here? Or has it just gotten fashionable for sustainable investing greenhorns to jump aboard the greenwash-critiquing bandwagon? I suspect it is a bit of both.
Of course, there are indeed an unfortunate number of misleading or false claims out there, perhaps just erroneously calculated or deliberately inflated, when it comes to the impact reporting of ESG and climate-related investments. To be clear, it goes without saying that there should be absolutely zero-tolerance for such behavior – and scrutinize we must, to protect the proper functioning of global capital markets and the rights of consumers. But for every legitimate critique of the spurious green promises and misrepresentations, there appears to be an almost equivalent number of misdirected claims against approaches that simply do not live up to the misinformed expectations of critics who do not fully understand them.
This is perhaps best illustrated through the enduring dichotomy of divestment versus engagement. The sustainability-minded investor has two options:
- Divest: to exclude certain “undesirable” companies for the avoidance of risk or as an expression of one’s moral values that sends a reputation-hitting signal, which potentially reduces a firm or industry’s license to operate. By avoiding sustainability laggards entirely according to a set of specific criteria, divestment approaches tend to exhibit better relative sustainability impacts, such as lower GHG emissions intensity, or a higher ESG score, at a current point-in-time.
- Engage: to maintain exposure to low sustainability-performing companies that allows the investor to retain a “seat at the table” and expert pressure to influence a company’s behavior, drive industry change, or advance a particular cause. Engagement may be active, for example, through investment stewardship efforts, or passive, through transparent and rules-based investment selection and weighting schemes that penalize such companies relative to their peers and incentivize them to improve. (Not to be confused with active versus passive investing as either camp could certainly adopt any of these engagement approaches.) By including such companies, the near-term ESG or climate impacts might seem muted, but carry the potential to improve over time as the industry converges towards better sustainability practices fueled by the growing pressure from investors.
Whether one opts for inclusive and broad market exposure with a system of penalties and rewards (a la engagement), divests entirely, or perhaps a bit of both across multi-strategy portfolios – it might be entirely appropriate to hold controversial stocks within an ESG or climate investment strategy. So long as it is completely transparent with its aims, the inclusion of companies that draw critical attention need not undermine an investment’s ESG-worthiness or merit accusations of green-washing. In fact, some suggest it may make sense to ditch divestment approaches altogether. So long as there continue to be investors in the secondary markets who do not share the same moral virtues, the divestment’s ability to move a company’s stock price will necessarily be dampened. So, while both sustainable investment styles may look “green”, perhaps only one of them is actually “greening”.