Can you have too much of a good thing? For regulators examining the recent proliferation of funds sold with an environmental, social and governance stamp, the answer may be ‘yes’. Fund managers who cannot justify an ESG brand image would do better to be wary.
According to data provider Morningstar, the number of “sustainable” – that is, ESG-focused – open-end and exchange-traded funds in the United States increased by 30% last year, to reach 392.
They attracted a record $ 51.1 billion in net inflows, more than double the amount in 2019, with investors drawn not only by ethical and environmental concerns, but also by the prospect of good returns. In the three years to the end of 2020, 75% of ESG funds ranked in the top half of their fund category for performance, according to Morningstar.
Reluctant to miss this windfall, managers of some long-established funds have reoriented them for the ESG era, adopting new investment strategies and ESG flag names. Morningstar reports that 69 have done so since 2013 – 25 in 2020 alone, of which the two largest were Invesco Floating Rate, now Invesco Floating Rate ESG, and USAA World Growth, now USAA Sustainable World.
“I’m sure some people, because ESG and responsible investing are sometimes hard to define. . . took advantage of the marketing opportunities that the ESG or sustainability label would have given them, ”says Meredith Jones, partner and global head of ESG at professional services firm Aon.
This rise of the ESG brand has caught the attention of the Securities and Exchange Commission, the US financial regulator, which has indicated that it will not tolerate “greenwashing” – the practice of embellishing or distorting ESG characteristics. of an investment product.
Speaking to his organization’s Asset Management Advisory Board in July, SEC Chairman Gary Gensler said, “There is no standardized meaning for these terms related to sustainability.”
He said SEC staff were considering asking managers to disclose the criteria they use to make such claims, as well as reviewing the policy on fund naming conventions. “If the name of a fund suggests a certain investment objective, investors expect to invest in that area,” Gensler said.
Regulators are also strengthening ESG disclosure standards. In Europe, the Sustainable Finance Disclosure Regulation, in force since March, requires asset managers to use a uniform set of reporting standards to disclose the impact of their portfolios on people and the planet.
The growing regulatory and reputational risk in sustainable finance was illustrated in August, when DWS, Deutsche Bank’s asset management arm, found itself embroiled in its ESG demands. Following allegations by Desiree Fixler, former head of sustainable development at DWS, that she distorted the rigor of its ESG processes, the SEC and BaFin, the German financial regulator, have opened investigations into the company.
DWS says it rejects Fixler’s claims and insists he has “always been clear” in his ESG reports.
Fury erupted weeks after not only Gensler’s remarks but also DWS’s announcement that nine of its ETFs would be renamed to include the ESG tag.
DWS struggles sent shockwaves through the ESG industry. While managers attempt to accurately predict how the SEC will approach their investment products, compliance experts advise detailed risk information and exercise caution in sustainability-related statements.
“ESG isn’t really new anymore, but overall it’s a new area in terms of compliance and enforcement,” says Jason Ewasko, Compliance Manager at Cipperman Compliance Services.
“I would recommend caution to any company looking to embed ESG into a strategy, model or portfolio,” he adds. “It’s clear to anyone half-awake that the SEC is taking a close look at this.”
The regulator’s first steps may be to require companies that use ESG-related fund names to justify them through detailed reports and standardized information on the risks inherent in these products.
“We expect, with the current administration, that there will be more advice,” said Anthony Eames, director of responsible investment strategy at Calvert Research Management. “I think managers are going to have to be able to prove that, if ESG is integrated, how it is integrated.”
Managers also expect regulators to pay attention to emerging policies among their foreign counterparts.
“One of the questions the SEC is asking itself right now for asset managers [is] how we see it in a global context, ”said Jens Peers, CEO and CIO of asset manager Mirova US.
“The industry wants to avoid having different rules in different parts of the world,” he adds. “At this point, I see no evidence that regulators are coordinating policies, but I am sure they are closely monitoring developments in other countries.”