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Oct. 15, 2019, 9:41 a.m. EDT

For ESG investors, the newest challenge is separating fact from ‘greenwashing’

How much is corporate talk of ESG principles just marketing?

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By Meredith Jones


MarketWatch photo illustration/iStockphoto

If you’re wondering whether environmental, social and governance (ESG) investing is taking off, consider this: the term ESG was used during 100% more S&P 500 corporate earnings calls in the second quarter of 2019 compared with the first quarter, according to FactSet.

And while the actual number of mentions was only 24 (compared with 12 in the prior quarter), if the pace of change continues, by mid-2020 roughly 20% of calls will proactively cite nonfinancial, ESG data.

But is the fact that companies are talking about ESG enough to guarantee environmental, social and governance action? That is a trickier question.

There’s no doubt of both a recent surge in ESG investments as well as an increasing number of ESG funds. Bank of America Merrill Lynch recently predicted that up to another $20 trillion could be invested in ESG funds over the next three decades.

Read: Number of young Republicans concerned about environment jumps in last five years

As more investors choose ESG over traditional indexes, the difference between being an ESG “winner” and “loser” could become much more meaningful. Companies that are left out of ESG indexes or receive poor marks from ESG ratings providers could take a performance hit to their stock price as they are increasingly shunned by shareholders. Funds that refuse to consider ESG factors or do so poorly will likely feel this pinch as well.

Read: When stock markets turned turbulent, ESG funds punched above their weight

But because ESG investing is still relatively new, the ability of shareholders, investment managers and individual investors to judge the meaningfulness of various ESG factors is still evolving. Whether a company or fund manager is honestly committed to improving their environmental, social and governance dynamics, and how crucial those elements are to ultimate financial success and sustainability, can be difficult to determine. That leaves the door wide open for what’s known as “greenwashing.”

Greenwashing is the practice of making statements or policies that make an investment (or investment fund) appear more serious about ESG than it actually is. Originally defined by Merriam-Webster as “expressions of environmentalist concerns especially as a cover for products, policies or activities,” the term has come to mean any faux or exaggerated ESG policy, or an environmental, social or governance project that has no meaningful impact except positive public relations.

How does a company greenwash? Let’s examine what some might call a pretty recent example. In August, Business Roundtable announced a new Statement on the Purpose of a Corporation signed by 181 CEOs who commit to lead their companies for the benefit of all stakeholders — customers, employees, suppliers, communities and shareholders. Among the signatories of this seemingly groundbreaking statement was Jeff Bezos, the Amazon /zigman2/quotes/210331248/composite AMZN +0.49% CEO.

Roughly one month after the Business Roundtable announcement, Amazon revealed it will end health benefits for 1,900 part-time Whole Foods associates . While the Business Roundtable provided Amazon with positive ESG street cred, the decision to cut insurance for part-time workers actually has the potential to have a real financial impact on employees and the company. After all, illness among the workforce tends to increase absenteeism, which is a drain on productivity.

Additional signatories to the Business Roundtable include American Airlines /zigman2/quotes/209207041/composite AAL +1.36%  , whose fraught history with labor as well as ongoing issues with the 737Max recently pushed its stock price to a three-year low, Wells Fargo /zigman2/quotes/203790192/composite WFC +1.55% , which has committed to environmental and social programs while continuing to grapple with governance issues , and Johnson and Johnson /zigman2/quotes/201724570/composite JNJ +0.98% , which has struggled to stave off massive lawsuits on products ranging from Risperdal to talcum powder to opioids.

Of course, all of these issues occurred in the past, albeit some more recentlythan others, and, one could argue, a new commitment to communities, employees and the environment could mean positive changes are afoot.

Read: Demand for climate-proofed portfolios was a key proxy-season theme this year

But herein lies one of the great conundrums of ESG investing: environmental, social and governance risks are generally forward-looking, and the data to prove whether they were meaningful (or not) can often only be judged in the rearview mirror. As a result, one must have some knowledge of what and how ESG policies are being implemented, a sense of the actors and market forces involved, and a tiny bit of faith to determine whether a company is interested in honest change or a good marketing campaign.

Read what Nasdaq’s former CEO thinks of the Business Roundtable statement and of ESG

Many retail investors don’t have time for that kind of individual company scrutiny, which is where ESG investment funds can come into play. Yet here, too, is a possibility for greenwashing.

While Vanguard has had two of the most high-profile ESG fund launches in recent years with its U.S /zigman2/quotes/205112700/composite ESGV +0.91%  and international /zigman2/quotes/206720360/composite VSGX +0.71%  ESG funds, it was hit by reports that those portfolios included nearly 30 stocks that were not actually ESG friendly . Vanguard quickly dropped the stocks from the portfolios, but it continues to rankle some ESG enthusiasts when it comes to shareholder engagement. In the wake of 2018 proxy season, for example, Vanguard ranked in the bottom 10 mutual-fund companies for its poor record supporting environmental proposals.

Read: As Vanguard launches a sustainable-investing ETF, its low fees are only one of the factors to consider

BlackRock /zigman2/quotes/207946232/composite BLK +1.22% , another giant money manager and proponent of ESG, also landed in the bottom 10, along with firms like American Century, Putnam and T Rowe Price /zigman2/quotes/203200152/composite TROW +1.01%  .

At the end of the day, it would be comforting to see an ESG label or a bold corporate responsibility initiative and know beyond a shadow of a doubt that a firm’s intentions and actions fit a more responsible and sustainable mold. Unfortunately, with stakes high, data still somewhat sparse and definitions loosey goosey, it may be some time before investors can have that degree of confidence.

So while transparency, standardization of terms and agreement about what constitutes meaningful ESG initiatives evolve, investors would do well to fact-check the ESG claims of any company or fund manager.

Meredith Jones is an alternative-investment consultant and author of “Women of The Street: Why Female Money Managers Generate Higher Returns (And How You Can Too)”. Follow her on Twitter @MJ_Meredith_J.

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