As published on ft.com, Monday 24 April, 2023.
An explosion in the number of ETFs that invest according to environmental, social and governance principles is fuelling concern among regulators that fund managers are “greenwashing”: using misleading environmental claims to entice well-meaning customers.
Exchange traded funds that use ESG metrics to inform investment decisions have developed into a key driver of new business for asset managers as more investors seek strategies that can deliver returns from doing good.
As a result, the number of ETFs carrying an ESG label more than doubled in the past two years, reaching almost 1,300 at the end of 2022, according to ETFGI, a London-based consultancy.
But all these ESG ETFs differ in their approach, ranging from “dark green” funds — designed to be compatible with the Paris Agreement goal of limiting global warming to 1.5C — to index trackers that retain significant exposures to fossil fuel companies, and to a wide variety of “thematics” that target specific ESG priorities.
“The speed of product proliferation means that investors have to do their homework with real care to ensure that they choose an ESG ETF that matches their needs and expectations,” says Deborah Fuhr, the founder of ETFGI.
ESG ETFs held global assets worth $394bn at the end of last year after registering net investor inflows of $74.7bn during 2022 — a drop of 54.5 per cent on the $164.3bn gathered over the previous 12 months, according to ETFGI.
That decline in new business for ESG ETFs last year was significantly larger than the wider 33.7 per cent drop recorded in the ETF industry’s overall net inflows.
This suggests that an increasingly fractious debate over ESG standards — along with mounting attacks by US Republican politicians — has started to damp investor demand. Republican governors from at least 19 US states have pledged to resist ESG investing, over antitrust, consumer protection and discrimination concerns.
Fund managers, on the other hand, complain that incomplete disclosures by companies, particularly regarding environmental data, combined with shifting regulatory requirements, have created real difficulties for product designers.
Problems are also evident in Europe, home to ESG ETFs holding $253bn-worth of assets. Possible accusations of greenwashing have prompted asset managers, including BlackRock, Amundi and UBS, to remove ETFs from the EU’s strictest ESG category, known as “Article 9”, which covers funds that hold sustainable investments or which target reductions in carbon emissions.
Amin Rajan, chief executive of the investment consultancy Create Research, says the reclassification of multiple Article 9 funds “shows that greenwashing was occurring but it remains difficult to say if this was deliberate or unintentional”.
However, the downgrading of almost all ETFs tracking Paris-Aligned Benchmark (PAB) and Climate Transition Benchmark (CTB) indices prompted the European Commission to issue a clarification this month. Fund managers will be permitted to carry out their own assessments for sustainable investments and they must also disclose their methodology, according to the Commission.