What’s in a name? Not as much as investors may assume when it comes to ESG (environmental, social and governance) mutual funds and exchange-traded funds.
“Right now, ESG investing in funds and ETFs is the Wild West due to the voluntary nature of ESG-related disclosures, absence of widely accepted terminology and limited-to-no enforcement,” said CEO Andrew Behar of the financial advocacy group As You Sow.
“We see funds with ESG in their names getting Fs on our screening tools because they hold dozens of fossil fuel extraction companies and coal-fired utilities.”
A four-month analysis of 94 mutual funds and ETFs with ESG in their names by graduate students at the University of California, San Diego, reached the same conclusion. Prospectus language has a relatively low correlation with its ESG rating. Based on empirical methods, the report showed that readers can’t tell the difference between a prospectus for a true ESG vs. greenwashing mutual funds and ETFs.
“The intent of this study is to underscore the necessity for the creation of a common glossary of terms and fund classifications subject to SEC enforcement,” Behar said. “This will help to eliminate confusion and misleading marketing, fund naming and prospectus language.”
As You Sow met with the SEC Division of Investment Management in January, shared the report and made these recommendations to address the issue of confusing and misleading fund naming and prospectus language:
- Standardize a glossary of ESG terms and a fund classification framework subject to enforcement by the agency.
- Require that all prospectus language be disclosed in a machine-readable format to enable automated comparisons of text vs holdings on a publicly available website so investors can rapidly spot issues.
- Continue research to examine a much larger set of funds and possibly integrate other ESG rating systems.
“Investors need asset managers to establish the philosophy underlying a fund and align the prospectus language and fund name with the intent and the holdings,” Behar said. “The problem is that there is no truth in labeling. If these funds were groceries, then a jar labeled ‘peanut-free’ may contain 19 percent peanuts and people with a nut allergy would end up in the hospital. When investors put their hard-earned money into an ‘ESG’ or ‘fossil-free’ fund, they expect to reduce their climate risk and not own big oil, coal and deforestation.”