What is ESG investing and how can you avoid greenwashing?

Updated July 10, 2023

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ESG investing refers to the use of ESG metrics to inform an investment strategy. This could be done by seeking and including companies with positive environmental impact, social responsibility, and corporate governance practices, or excluding companies with negative behaviors.

The various types of ESG investing have been grouped by how the ESG metrics are used to build or refine a portfolio of investments. The 4 main types are outlined below:

  1. Exclusionary investing or screening is where companies that don’t meet ESG criteria are removed from a portfolio. Companies in controversial industries or sectors may also be removed. For example, a company that makes revenue from tobacco may be removed from a portfolio.
  2. Inclusionary investing or positive screening is where companies with strong or rapidly improving ESG policies are actively searched for and included in investment portfolios. This could include an equity fund that invests in oil or gas instead of coal companies which are deemed to have higher fossil fuel productions.
  3. ESG integration is where ESG metrics are used alongside traditional financial factors to assess the value of investment in a company.
  4. Impact investing targets investments which will lead to positive measurable social or environmental goals while still providing promising financial returns. These investments are often more focused on a specific goal and could include targeting investment in renewable energy companies.

A variation of ESG investing is Socially Responsible Investing (SRI), which focuses mainly on the social aspect instead of the three ESG areas.

The lack of standardized sustainability or ESG-related criteria describing a sustainable or ESG-aligned investment means individual investors must decide what level of sustainability or ESG criteria they are comfortable with. Greenwashing can arise with the lack of standardized metrics as fund managers may decide to allow controversial industries in their more sustainable funds.

Greenwashing is a misleading set of claims made about the positive impact of a company, product, or service on the environment. In ESG investing, a fund manager may include oil companies in their sustainable fund since they are deemed to have lower carbon emissions compared to coal companies. This could act as a form of greenwashing as many investors may expect both industries to be excluded from a sustainable portfolio.

So Greenwashing Risk is the risk of a company or a fund conveying a false impression or providing misleading information about how funds or a company’s products are more environmentally sound. At Sustainable Platform, we have developed a greenwashing risk metric to show the risk of a company to negatively impact the environment, as a check for the company’s environmental claims. We also measure this risk at a portfolio or fund level based on the holdings’ greenwashing risk.

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