The scale of greenwashing in the asset management industry was laid bare in new research from think-tank, InfluenceMap, which claimed most ESG and climate strategies are not aligned with the goals of the Paris Agreement and often invested in the world’s top polluters.
The report, titled Climate Funds: Are They Paris Aligned?, argued the wide range of both climate-themed terms and lack of universal standard or regulation makes it difficult to compare products on a like-for-like basis.
The rise of ESG has been nothing short of dramatic with the rise of products claiming to adhere to climate or environmental, social and governance (ESG) considerations reaching $1.7trn assets under management by the end of 2020.
Overall, the report found that of the 593 equity funds falling into the broad ESG category, some 421 of them – or 71% – scored negatively on Paris Alignment suggesting their portfolios were contrary to global climate targets.
Even the majority of the seemingly stricter 130 funds in the climate-themed category fell short of the mark with 55% receiving negative Paris Alignment scores. Though, it is worth noting the vast range in these products’ Paris performance as scores ranged from positive 90% to as low as negative 42%. Of the six fund subtype within the climate category, the most unaligned were in fact the products labelled Paris Aligned with an average score of -19%.
Also, climate-themed funds continue to have $153m of aggregate exposure to the fossil fuel production value chain including weightings to companies such as TotalEnergies, Kinder Morgan, Enbridge, Neste, Halliburton, Chevron and ExxonMobil.
Although 25% of climate funds weight to companies with fossil fuel reserves, this number jumps to 42% for broader ESG products, on average appearing to indirectly own more reserves per US dollar than the S&P 500, the report said.
Unsurprisingly, clean energy funds such as the iShares Global Clean Energy ETF (INRG) were the exception to the rule. Being highly invested in the renewable power sector, these products received consistently positive Paris Alignment scores.
Overall, though, a large portion of funds examined in the report exhibit similar levels of climate misalignment to those of regular market indices.
A large part of the blame for this, the research said, lays with passive strategies which seek to track market benchmarks as closely as possible, while applying exclusion or weighting criteria. These strategies result in portfolios only slightly differing from parent benchmarks or featuring exclusions for sectors such as fossil fuel extraction while most of their remaining baskets remain similarly misaligned with the Paris Agreement.
Speaking on the negative impact of passive funds on climate progress, the report said: “In the case of weighting strategies, a fund will continue to hold the same companies as the underlying benchmark, with weighting adjustments only leading to marginal changes in share ownership of misaligned companies.
“Exclusion strategies do not perform much better, with many 'fossil fuel reserves free' funds continuing to invest in downstream fossil fuel companies, and 'low carbon' funds divesting from the fossil fuel value chain while continuing to hold problematic automotive and power sector holdings. Strategies such as these therefore commonly result in funds whose portfolios do not differ significantly from the market as a whole when it comes to climate alignment.”
While such issues may not work in contradiction with a fund’s goals, they point to a lack of consistency and transparency throughout the sector of ESG and climate funds with climate targets, the research added.
“As a result, it remains difficult for investors to determine what these funds' descriptors mean in practice relative to the market, to each other, and to their own investment goals.
“The findings exposed by this research highlight a number of issues in the climate-themed and ESG fund markets and suggest a need for closer oversight of the sector.
“Policy to address this need is currently almost exclusively being considered and implemented in European markets, through mechanisms such as the EU’s Sustainable Finance Disclosure Regulation (SFDR) and Taxonomy, as well as initial steps by regulators in the UK.”
At present, the worst-performing fund issuer of those examined by InfluenceMap was State Street Global Advisors (SSGA) with an average portfolio Paris Alignment score of -14%. Meanwhile, the best performing issuer was Invesco, scoring positive 23%, while the world’s largest asset manager, BlackRock, scored -6%.
The think-tank’s report highlights just how important investor due diligence is when building a portfolio that tries to balance risk, returns and sustainability profiles. Ultimately, it also paints a rather bleak picture for passive funds, which – except in peripheral thematic exposures – seem reluctant to sacrifice market beta to better-optimise their alignment with climate goals.
Some might argue continuing to hold the world’s worst polluters allows fund investors and issuers to actively engage and apply pressure on these companies to change their ways, however, this depends entirely on two factors.
First, the effectiveness of large issuers’ small and normally under-resourced stewardship teams, and second, the extent of meaningful leverage issuers they have, given companies know fund providers are reluctant to stray too far from their parent benchmarks. Furthermore, the conversation surrounding physical ownership changes completely in those ESG funds which allow securities lending, a process that has its own challenges.