Leading investment experts are calling for the country's financial regulator to act swiftly to stop the mis-labelling of green investment funds by some of the world's biggest asset managers.
They believe that investors' voracious appetite for funds with an ethical, ESG (environmental, social and governance), sustainable or SRI (socially responsible investing) bent is resulting in some managers taking shortcuts in order to jump on the bandwagon.
Some, they claim, are badging funds as SRI or ESG-focused when actually the underlying investments are little different from similar mainstream funds that they manage.
Going green: Investment experts believe that investors' voracious appetite is resulting in some managers taking shortcuts in order to jump on the bandwagon
Catherine Howarth, chief executive of responsible investment campaign group ShareAction, says the mislabelling of such funds is a 'worrying problem'.
She told Wealth: 'Too many investment managers have hurriedly attached green labels to funds that are anything but green friendly. It's wrong, plain and simple. People want to buy these funds and they should get what they think they are buying.'
Howarth welcomes the recent decision of the City's regulator – the Financial Conduct Authority – to start to look at ways in which investors can make more informed ESG investment decisions.
But she believes regulatory intervention to stop widespread fund mis-labelling cannot come soon enough. 'Unless it acts soon, the regulator could be overseeing a major mis-selling scandal,' she says.
The FCA says it is confident it can come up with its 'new proposals' by spring next year. This week, a 'disclosure and labels advisory group' put together and overseen by the regulator will meet for the first time to look at how ESG fund labelling can be improved.
Widely respected investment manager Alan Miller, co-founder of wealth manager SCM Direct, is not impressed. He has long called for the regulator to act to stop the mis-selling of ESG funds.
He says: 'While the FCA launches yet more consultations, more discussion groups and review papers, more and more innocent investors looking to do good as well as take responsibility for their future financial health are being mis-sold ESG investment funds.
'The blatant greenwashing occurring in the investment funds industry – with no checks or action by the regulator – is scandalous and makes a mockery of green investing.'
Greenwashing comes in many forms, but in terms of fund management it is when investment managers badge funds as green when the underlying investments are not as green as they claim.
Academic work published earlier this year by EDHC Business School highlighted the portfolio greenwashing that Miller refers to as a problem. 'Investment managers may claim that their funds produce a positive impact on the environment,' it said, 'when in fact they are not managed in a manner that is consistent with promoting such an impact.'
Last week, Miller conducted research for Wealth into the credentials of some funds that claim to take into account sustainability, ESG and 'impact' factors in the construction of their portfolios.
To put it mildly, the results make for interesting reading. Some funds, he believes, pay mere lip service to the green issues they promote in their literature. His starting point was to look at the 343-odd sterling denominated funds that are classified by scrutineer Morningstar as having a 'sustainable investment' focus and are available to UK investors. Morningstar leads the way in rating funds on sustainable issues, awarding the most compliant a maximum five stars.
Miller then compared the portfolios of individual sustainable funds against those of similar funds run by the same investment company, but which are not badged as green. In some instances, the portfolio differences are minimal, throwing into doubt the veracity of the sustainable label.
One such case involves investment giant Vanguard. Only last week, ShareAction's Howarth said Vanguard was a 'really poor performer' when it came to responsible investing. Vanguard runs the £389million fund SRI European Stock. Its investment objective is to mirror the performance of the FTSE Developed Europe Index, an index comprising 614 listed European companies. The fund does this while excluding companies in the index which do not meet socially responsible criteria.
These are defined by Vanguard as companies 'that are, or have, engaged in activities that result in serious violations of the United Nations Global Compact' – a non-binding UN code which companies worldwide are encouraged to adhere to on issues such as labour rights and the environment. Vanguard also says it will avoid companies that 'derive revenues from the production of controversial weapons such as cluster munitions, landmines, biochemical and nuclear weapons – and those involved in the manufacture and distribution of tobacco products'. Alongside this fund, Vanguard also runs FTSE Developed Europe which simply tracks the performance of the same index – but all SRI considerations are ignored.
For all of Vanguard's bluster about the socially responsible approach of the SRI European Stock, its portfolio is little different to that of FTSE Developed Europe. Just 25 of 614 companies have been screened out because they do not meet its socially responsible criteria.
And that still leaves a plethora of stocks in the SRI European Stock fund that most investors would expect to be routinely excluded from green ethical funds. For example, drinks companies (the likes of Heineken and Carlsberg); gaming businesses (Entain and Evolution); mining giants (Rio Tinto and Anglo American); and oil producers such as BP and Shell. It even includes building supplies company Kingspan, criticised in the Grenfell Tower inquiry.
Furthermore, for all of its talk about excluding companies that fall foul of the UN Global Compact code, it has adopted a hitand-miss approach. According to MSCI, only one of the four UNGC 'violation' stocks in FTSE Developed Europe are excluded from SRI European Stock – and only one of the four 'very severe controversies' stocks.
Other funds, says Miller, seem to have been misclassified by Morningstar as sustainable investments when they are clearly not. For example, the Lyxor MSCI Emerging Markets fund explicitly states in its prospectus that sustainability will not be a consideration because its objective is to track the MSCI Emerging Markets Index.
Meanwhile, the £7billion Royal London UK Core Equity Tilt Fund says it 'seeks' to reduce the carbon intensity of its portfolio by between 10 and 30 per cent. But MSCI says it scores little better on this measure than a UK index-tracking fund. The fund has 9 per cent of its portfolio in oil stocks.
Vanguard said its European SRI Stock Fund had been created 'in response to demand from clients wishing to screen out certain activities such as breaches of the UN Global Compact and tobacco'. It added: 'Whichever way investors wish to express their ESG preferences, we will treat investors fairly and give them the best chance of investment success.' SCM Direct's Miller believes 'urgent action' is required to ensure investors are no longer mis-sold ESG funds. The FCA, he says, should force funds to publish full details of their holdings so people can see what is in the fund, not just what the label or categorisation says. He adds: 'This level of transparency has been available to US investors for all funds since 2004, yet 17 years later UK investors are still being treated with contempt through dodgy and deceptive ESG products.'
How to make sure funds ARE ethical
Julie Dreblow has spent the past 25 years championing the cause of ethical investing – first at Friends Provident (a pioneer in ethical investments) and more recently at SRI Services.
Like ShareAction's Catherine Howarth and SCM Direct's Alan Miller, she believes it is time for greater regulation of the socially responsible investing sector.
Indeed, she is part of the task group put together by the Financial Conduct Authority to look into ways of improving the labelling of SRI funds.
Although she accepts that greenwashing among the investment industry is a problem – not helped by fund groups entering the SRI arena with little or no relevant expertise – she says 'communication' is the key issue that needs to be tackled.
Her view is that ethical investing is a broad church.
So, some investors are not willing to have any investments in tobacco stocks, oil companies, arms manufacturers or drinks businesses.
In contrast, other investors prefer to back companies which are involved in renewable energy or countering climate change. The investment industry, she says, must do more to ensure these different types of ethical investor are directed to the most appropriate funds – essentially through better fund labelling.
SRI Services, founded by Dreblow 11 years ago, runs a website – fundecomarket.co.uk – that allows investors to review all the different socially responsible investing styles.
Once they have found one that suits them, they can then get a list of appropriate funds.
Dreblow currently advises wealth manager Interactive Investor on the ethical funds that make it on to its list of top 40 buys (the ACE 40).
Among those listed are Baillie Gifford Global Stewardship, Royal London Sustainable Leaders and Montanaro Better World. Further details at ii.co.uk/ii-ace.
According to research by the Financial Conduct Authority, more than 70 per cent of people now want to invest in a way that protects the environment.
The same percentage would not put money into 'investments which are unethical'.