October 22, 2024
With each new natural disaster, many of us are feeling the seriousness and urgency of climate change mounting, leading us to make more life decisions with this looming issue in mind, including the way in which we invest our money. Some investors have shifted towards "clean" investing by using ESG funds (Environmental, Social & Governance), with the hope that their dollars will support companies with lower fossil fuel usage and carbon emissions. While ESG funds have been around for 20 years, probably due to the rising concern with climate change, ESG investing has seen a rapid growth in popularity recently, particularly between 2017 and 2022.1
Unfortunately, as ESG investing has gained traction, researchers and regulators have increasingly revealed problems with this type of investing. Historically, ESG funds have not been carefully regulated, allowing some companies to "greenwash" their funds. Greenwashing occurs when a company misrepresents its investment products as environmentally friendly. This can be as simple as a mutual fund company attaching "ESG" to a fund name without properly screening the companies within the fund for various environmental metrics.2
According to the Southern California Law Review, while the Securities & Exchange Commission (SEC) tried to crack down on the misleading name issue by making updates to Rule 35d-1 (the "Funds Names Rule") in 2022, the degree to whether this adjustment was effective, not to mention sufficient, is highly debatable.2
In his article, "An Inconvenient Truth About ESG Investing," Sanjai Bhagat writes that researchers compared the ESG record of U.S. companies in 147 ESG fund portfolios to that of U.S. companies in 2,428 non-ESG portfolios. They found that the companies in the ESG portfolios had worse compliance records for both labor and environmental rules. Bhagat goes on to cite a number of similar research examples and concludes saying," Funds investing in companies that publicly embrace ESG sacrifice financial returns without gaining much, if anything, in terms of actually furthering ESG interests."3
In short, not all ESG funds may be a wise option for investors who earnestly want to address climate change through their investments. However, if you do choose to invest using ESG funds, it is important to do your homework. Just as you might read the ingredients of a pre-packaged food item, take a closer look beyond the label. Start by Googling the mutual fund/ETF and search for the fund's holdings. This should provide you a list of companies and the percentage of the fund allocated to each company.
Better yet, investigate the ways in which you can have the greatest impact on climate change. The single best book l've found on this topic is called Drawdown: The Most Comprehensive Plan Ever Proposed to Reverse Global Warming by Paul Hawken. This book, in which Hawken outlines the 100 most substantive solutions to reverse global warming, provides not only meticulous research by leading scientists and policymakers around the world on the topic, but also addresses the topic within a framework of hope and positivity.4
- Carrie McDonnell
1. https://www.bankrate.com/investing/esg-investing-statistics/
2. https://southerncalifornialawreview.com/2024/04/16/whats-in-a-name-esg-mutual-funds-and-the-secs-names-rule/
3. https://hbr.org/2022/03/an-inconvenient-truth-about-esg-investing
4. Drawdown: The Most Comprehensive Plan Ever Proposed to Reverse Global Warming
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