JEFF PRESTRIDGE: ESG investment sector is a mess

At some stage this autumn, the country’s financial regulator will publish its proposals on protecting green investors from ‘greenwashing’ – investment firms making exaggerated, misleading or unsubstantiated claims about the ESG (Environmental, Social and Governance) credentials of their products. 

When exactly I’m not sure – the regulator’s autumn is sometimes our winter or spring. But they are recommendations that cannot come soon enough because the burgeoning ESG investment sector is currently a mess, awash with funds that are simply not ESG fit for purpose. 

Indeed, if investors were to look under the bonnet of some of these green funds and examine their portfolios, they would be shocked and probably demand that the manager be handcuffed to the nearest railings and pelted with raw eggs or daubed in green paint. 

Tobacco stocks in an ESG fund? Drinks company shares? Gambling shares? Oil and gas companies? Yes, ladies and gentlemen, some funds marketed on the basis of their ESG friendliness are awash with such sin stocks. 

As a result of ineffective regulatory oversight by the Financial Conduct Authority (a phrase I’ve used a few times over the years), investors are being hoodwinked every day into buying funds that they think are green, but are anything but. It’s like the Wild West. To date, not one investment firm has been publicly fined or disciplined for the greenwashing that the FCA wants to stamp out. A joke. 

Fund manager Alan Miller, cofounder of investment house SCM Direct, is a longstanding critic of the way investment funds have played footloose and free with ESG labels. He refers to the ‘Alice In Wonderland world’ of ESG funds. Miller believes the flaws run deep – starting with the way companies are ESG rated by ratings agencies (the likes of Morningstar and MSCI) through to the rules governing how a fund can be classified as ESG. 

At a company level, a tobacco firm can get a good ESG score by virtue of the fact that it is better than its peers. 

This is despite the fact that the World Health Organisation says that every year, the tobacco industry ‘costs the world more than eight million lives, 600million trees, 200,000 hectares of land, 22billion tons of water and 84million tons of CO2.’ 

Also, given that ESG ratings apportion equal weightings to environmental friendliness, social responsibility and corporate governance, a company can keep destroying the environment, but get a high rating because of its commitment to the ‘S’ and ‘G’ of ESG. 

This all explains why companies such as FTSE100 tobacco stocks BAT, mining giant Glencore and oil and gas companies BP and Shell all get overall ESG ratings from agency Refinitiv in excess of 90 out of 100.

It is also the reason why many ESG investment funds include these companies in their portfolios. I’m not sure I’d be happy about that if I were a green investor. 

As for investment funds, the rules they currently have to adhere to are similarly loose. The main classification system allows a fund to be ESG as long as it promotes stocks with good governance – they do not have to possess good environmental characteristics. 

Last week, Miller analysed the portfolios of 224 ESG investment and exchange traded funds that are promoted to investors in the UK. To his horror, he discovered that 11 of these have more than 10 per cent of their portfolios invested in sectors that you wouldn’t think would be anywhere near an ESG portfolio – alcohol, tobacco, gambling, oil and gas. 

The worst offender is Royal London UK Core Equity Tilt – a £6.6 billion fund investing in some of the UK’s largest companies that are good when it comes to ESG. More than a quarter of its portfolio is in alcohol, tobacco, gambling and oil and gas stocks. 

On Friday, Royal London said the fund did not exclude investing in any sectors, but had less exposure to sin stocks than the index. 

That’s OK then (written with sarcasm). 

As for the FCA, it told me on Friday that greenwashing ‘undermines confidence’ in ESG products – and that its proposals on the labelling of ESG funds would ‘help ensure that consumers understand where their money is invested’.

I do hope so, although I – and Alan Miller – fear another regulatory whitewash.