Do greenwashing fears scare investors from ESG-defined funds?

The naming of ESG funds could be a hindrance to their flows as growing regulatory enforcement action against greenwashing prompts investors to seek out those funds which “fly under the radar”.

Last week, research by Morningstar found that flows into sustainable funds had fallen by 91 per cent in the past quarter, with Vanguard suffering a particularly rare fall from grace and reporting net outflows.

The latest quarterly data showed inflows into Australian and New Zealand sustainable funds fell 91 per cent to an “anaemic” $214 million, down by more than $2.4 billion.

Vanguard received infringement notices from the Australian Securities and Investments Commission (ASIC) last December for alleged greenwashing on the product disclosure statements on its Vanguard International Shares Select Exclusion Index funds.

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This was not the only fund to face action, with Diversa Trustees, Mercer Super and Future Super also seeing regulatory action and ASIC stating it would be one of its enforcement priorities for 2023. This was backed by the government, which had provided an extra $4.3 million for ASIC as part of its Australian Sustainable Finance Taxonomy.

In the latest Adviser Ratings Landscape report, it noted greenwashing was the biggest risk for fund managers considering launching a new ESG fund, while others feared that ESG would become a political weapon.

This was echoed in the Morningstar report, which found just two funds were launched in Australia in the past quarter compared to eight in the previous quarter. In 2022, there were 23 across the year and 36 in 2021. 

As a result, funds were being defined as “covert” and “overt”; overt being those marketed on the basis of their ESG credentials and covert being funds that had strong externally validated ESG credentials from Morningstar/Lonsec but were not named or marketed as being ESG funds. 

Overt fund names included words such as “ethical”, “responsible”, “sustainable”, “ESG”, “stewardship”, “impact”, “carbon” and “advocacy”, among others while covert ones excluded them.

Covert funds had $28.1 billion in net assets while overt funds had $33 billion.

“We believe the (currently) less favourable marketing approach of ESG funds (to be covertly ESG) will become more favourable. Being overtly ESG could potentially attract the wrong sort of attention, and that would make being under the ESG radar rather than above it the more appealing option,” Adviser Ratings said.

The 2022 annual benchmarking report by the Responsible Investment Association of Australasia (RIAA) also indicated that fund managers varied widely in how they chose to design and define their responsible funds. Options included ESG integration, negative screening, norms-based screening, corporate engagement, positive screening, impact investing and sustainability-based investing.

“Responsible investment approaches continue to develop and grow as investment managers respond to different investor needs and expectations and test new approaches to achieve better outcomes”.

It also noted there was a trend toward “experimentation with new tools to convey messages about the positive impacts and outcomes that investments deliver alongside financial returns”.

ESG integration was the most popular responsible investment approach used by investment managers in Australia in 2021, representing $752 billion in funds, up from $628 billion in 2020. 

Investors cohorts
While the threat of greenwashing was omnipresent for fund managers, it was also a concern for consumers, as a separate RIAA study of over 1,000 consumers found 72 per cent were aware of greenwashing, particularly in the younger Gen Z cohort.

This concern was among the factors hindering them from making the switch to a responsible fund or provider, they said.

“Alarmingly, almost three-quarters (74 per cent) of those who already have responsible investments and four out of five (82 per cent) Australians that are considering investing in responsible investment products in the next 12 months are concerned about greenwashing.

“Greenwashing is more of an issue for people who know what responsible investment is, than those that are unsure or unfamiliar with the term.”

External approval of a fund’s ESG credentials was also important to them, with 75 per cent saying they would be more likely to invest in responsible investment products that had been certified or labelled as responsible by an independent third party.

Some 77 per cent of those who were “considering” investing in responsible investments over the next five years said independent responsible investment labels would help convince them to do so, rising to 88 per cent of those who already did or planned to do so in the next 12 months.

However, research by Netwealth of 1,600 investors in 2021 found 36 per cent classified themselves as “doubters”, who held no strong opinion about ESG and did not typically invest in responsible investments. A further 20 per cent were “sceptics”, who did not understand responsible investing and would not invest responsibly even if it was financially beneficial to them.