Elephants in the sustainable funds room — why green funds fail

I

have always been amazed by how many fund groups seem led by their marketing departments rather than their investment departments. There is nothing wrong with wanting to invest ethically will your wealth but many fund groups mislead investors by claiming that investors could have it all, do good and outperform because ‘good’ companies will necessarily outperform ‘bad’ ones. Our analysis of various UK ethical equity funds shows their performance has been woeful, not just during the recent period when tech stocks fell, and oil stocks rose (the perfect storm for many of these funds) but going back a full five years.

The table of funds and their performance is below – we highlighted in red when the various UK ethical equity funds/ETFs underperformed the UK stock market:

Source: SCM Direct.com

Unfortunately, the UK stands apart from other markets in the extent of underperformance – the European regulator, ESMA found that ‘even after controlling for fund characteristics and differences in portfolio exposures, ESG funds remain statistically cheaper and better performing than non-ESG peers between April 2019 and September 2021’. They analysed 6,528 equity UCITS funds within Europe.

But it is not just the stock selection within these UK ethical funds which is hugely divergent, but the views of different funds and different ESG rating agencies on whether a particular company is rated highly or lowly. You might think a large oil & gas stock like Shell would be lowly rated by the ESG data providers, but it depends on who you use it seems. According to MSCI, Shell is AA rated (the second best out of 7 categories), according to Refinitiv it gets a 93 out of 100 score, but then according to Sustainalytics (owned by Morningstar) it only scores 2 out of 5 for sustainability and has material ESG issues re emissions, carbon and health & safety.

It is becoming increasingly evident that the ESG scores on which many of these funds are based is completely random and often bogus. Even the FCA has belatedly spotted this week that ESG data and providers might need regulatory oversight and is seeking Treasury approval to extend its ‘regulatory perimeter’ to allow enhanced regulation. However, sadly words and actions are miles apart at the FCA and despite numerous examples we have identified over many years of brazen greenwashing by major funds and firms, I am still not aware of a single firm or fund in the UK who has been publicly fined or reprimanded by the FCA for greenwashing.

UK retail investors deserve a fund industry and a fund regulator that is fit for purpose. When it comes to ethical investing or ESG, neither is.

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