Is Your ESG Legit? How to Identify Funds that Meet Your Standards

How can you be sure you are selecting the most appropriate ESG-themed or sustainable investments for your clients?

The preliminary steps are familiar to advisors: Understand your client’s goals and values and identify the available products that are best suited to them. Are there specific companies or industries that your client wants to support, like renewable energy? Are there industries that your client feels uncomfortable with, such as tobacco? Does your client have a religious faith that guides their consumer choices? Are there specific social causes that your client would like to address through their investments, such as gender equality?

Once you have a clear picture of what your client values, you can begin to evaluate the socially responsible, values-based and/or sustainable investment options. The following questions will help in your process:

1. How does the fund or fund manager define “sustainable”?

The fund manager should have a clear way of communicating their values and framework in the investment selection process; you should be able to easily understand the focus of the investment process and the fund’s objective.

The fund’s prospectus should corroborate the fund manager’s claims to sustainability. When sustainability claims appear in a firm’s marketing materials but not in the fund’s prospectus, it is very likely that the fund manager is only aspiring to incorporate sustainability. A prospectus that contains the language like “ESG consideration” is not as strong as a prospectus that spells out a sustainable investment process with specific ESG criteria.

Ideally, fund managers should also be complementing third-party ESG data with proprietary due diligence. Advisors should be cautious of any fund that exclusively uses an external vendor for ESG research, as sustainable and responsible investment research is a holistic process with many conflicting points of view. In the broad definition of sustainability, even the “experts” disagree – and disagree a lot. For example, CSR Hub, a data provider for the sustainability industry, found that the correlation between MSCI’s and Sustainalytics’ ratings was only 0.32.

2. What’s in the fund’s portfolio?

Reviewing the fund’s holdings is an important and sometimes overlooked step that yields tremendous insight.

A portfolio should be reviewed holistically. A firm that invests for advocacy purposes, for example, generally is required to own securities of the issuer with which they are engaging in proxy work. Some funds, while identifying themselves as sustainable, may have large and diversified exposures in industries like hydrocarbon, mineral extraction, or other questionable industries. If the fund does own these positions, explore the fund managers’ rationale and how they are defining sustainability. Does their definition align with your client’s values? If a fund is in alignment with some of your client’s values but not with others, that can be a sign for the advisor to keep searching.

3. Does the fund provide transparent reporting that details its progress and contribution to sustainable outcomes?

An impact report measures the fund’s progress toward stated sustainability goals and explores in detail how the fund’s managers are incorporating sustainability. Published impact reports demonstrate accountability to shareowners and a commitment to transparency. Fund managers can choose to align their goals with self-generated or third-party benchmarks.

We use an impact report to gauge our portfolios’ contributions to the United Nation’s 17 Sustainable Development Goals. This communicates the values, goals, and metrics used to evaluate criteria in a way that reflects the fund’s overall strategy. The approach shows, for example, that 58.1% of holdings in our sustainable strategies have implemented renewable energy quantitative targets and deadlines compared with 19.4% of MSCI ACWI. For those seeking to invest in solutions that ease CO2 emissions, this type of benchmarking paints a clear and accurate picture.

Another way to evaluate a sustainable fund’s legitimacy is to look back at its proxy voting record. Form N-PX can be found among the SEC’s filings database for every registered investment company, and details how fund managers have voted on items put before shareholders – including their votes on environmental and social proposals. While it isn’t necessary or even appropriate for a fund to vote in favor of every single ESG-related shareholder proposal, consistent votes against proposals in areas that the fund claims to support through their investment process can be a major red flag.

In the past year, the SEC has taken measures to identify and sanction ESG and sustainable greenwashing within the fund industry, and investors can be optimistic that clearer, more standardized guidelines are coming. In the meantime, the research available to aid in values-based fund selection provides advisors with the wonderful opportunity to engage and connect with their clients in more meaningful conversations, and strategies.

Stephanie Ashton is manager of corporate social responsibility and Patrick Drum is a portfolio manager and senior investment analyst at Saturna Capital.

Read more articles by Stephanie Ashton, Patrick Drum