By BNY Mellon

The ESG movement has grown, but so has anxiety about greenwashing. While the funds appear to be surviving covid-19 and are here for the long haul, they need common standards to better demonstrate what they’re invested in.

Even before COVID-1 9 exposed the importance of public health policies to investments, there were reasons to think about environmental, social responsibility and corporate governance (ESG) issues when making investment decisions.

There were Australia’s wildfires, which have cost that country billions of dollars; calls for companies to include more women on their boards; and the WeWork IPO that wasn’t, an alleged governance failure that slashed the market capitalization of a much-hyped unicorn.

Investors are growing more attuned to these factors than ever before, and many funds consider them a strategic hook. Almost every major asset manager now offers an ESG strategy, and, until the pandemic shuttered the global economy in March, new financial products were launching by the month. The narrative is not just showing up in equity portfolios. It is also entering fixed-income markets and even money market funds.

At the same time, the broader adoption is bringing about new questions and challenges about analytics and reporting tools covering the now $30 trillion global sustainable investment industry. Matt Orsagh, Senior Director of Capital Markets Policy at the CFA Institute, says he has met with professional and institutional investors around the world about ESG integration as part of a collaboration with the Principles for Responsible Investment, a UK-based industry group. He says many investors were confused about what the ESG label really stands for.

“There was one concern we heard everywhere we went: that there is no agreed-upon definition of what ESG means, so funds may be marketing something that may not be in line with what a client wants,” Orsagh notes. “Investors have to do their own homework to know if something that is labelled ESG is really right for them.”

Anxiety is especially high about a practice known as “greenwashing,” where an investment or company claims to be environmentally friendly but may not be. The field of “impact investing” also is causing concern. While it involves investors changing the environmental and social impact that their capital is having, some worry good impacts may come at the cost of economic gains, or that managers will cherry-pick impacts to show only what is good.

It is difficult for investors to understand how to value a company’s ESG standing, when opinions among data vendors and ratings firms can vary so widely. At BNY Mellon, which is helping the industry to develop common standards by mapping investor preferences to ESG fund holdings, a study published in February found 61.7% of issuer respondents now monitor their ESG ratings, up from 45.2% in 2017.

Without substantial improvements, better disclosure and higher quality information from the more than 250 data vendors in the space, the entire ESG movement runs the risk of returning to a momentary marketing fad, say some experts in the field. The US Securities and Exchange Commission is reportedly probing the validity of ESG funds and what investments are inside them.

In October, the European Union passed ESG disclosure regulation requiring funds to explain how they consider sustainability factors that materially affect their investments.

A new EU taxonomy for ESG finalized earlier in the year also aims to coordinate standardization across member states, and sets out a series of criteria to determine whether the activity being financed has a sustainability component.

Here to stay

Another concern is whether investors will continue to pursue these strategies as the economy tries to recover from the current pandemic. Some early indications seem to suggest ESG funds may have outperformed non-ESG strategies during the crisis.

Natalie Westerbarkey, Head of EU Public Policy at Fidelity International, says one of her priorities is making sure the firm still continues its green agenda during and after the pandemic. Since 2019, “All analysts must look at ESG aspects and have a view on them,” she says. “We already have data points that ESG seems to be outperforming other types of usual assets, especially in downturns.”

In their flight to safety, however, investors may go back to focusing on core tenets of their business for a while. Some who embraced ESG as a marketing gimmick during the decade-long bull market may lose their enthusiasm for the movement. But most experts agree ESG is here to stay.

Before COVID-19, fund flows into ESG were nothing short of staggering. Last year, the industry added $21 billion to ESG mutual funds and exchange-traded funds (ETFs), according to fund tracker Morningstar, bringing the total assets under management to about $140 billion. In 2010, total net flows were less than $10 billion.

US-domiciled assets using sustainable investing strategies totalled $12 trillion as of 2018, up 38% from 2016 levels, according to the Global Sustainable Investment Alliance. Meanwhile, green, social and sustainability bond issuance reached around $325 billion in 2019, according to Moody’s Investors Service.

The inflows have lit a fire under an investment management industry that is already struggling to justify its fees at a time of increased passive investing. After US money manager Federated Investors acquired European ESG specialist Hermes Fund Managers in 2018, it changed its name to Federated Hermes out of a belief that responsible investing was the future.

Asset managers also see an opportunity to attract millennials — both as investors and employees. “The values of a new generation are beginning to influence how companies and investors think,” says Joshua Kendall, Senior ESG Analyst with BNY Mellon’s asset management subsidiary. “This change empowers millennials.”

Public pension plans, sovereign wealth funds and other institutional asset owners are increasingly including ESG in their investment processes. The US investment industry does have a long, sustainable investment history. But, it was the European institutional investors, particularly the Scandinavian funds, along with some pension funds in Australia and New Zealand, who in the 2000s began loudly voicing their sustainable investment concerns.

Over time, ESG investment evolved. It started with the exclusion of companies perceived to have questionable ethics, such as tobacco stocks or firearms. Today, the idea is to identify companies perceived to have positive, sustainable business practices, which investors believe will outperform.

As ESG entered the investment office, however, the challenge of identifying a high-scoring and potentially economically successful company became exponentially greater. How to value a company’s ESG standing, when opinions could vary so widely and reliable data were often hard to come by, was a dilemma facing every investor.