Produced as part of the EDHEC-Scientific Beta “Advanced ESG and Climate Investing” research chair, a new study entitled “Doing Good or Feeling Good? Detecting Greenwashing in Climate Investing” shows that traditional climate investing strategies do not live up to the promises of their promoters.
Among the key take-aways from the study:
- Even though investors and managers communicate extensively on the use of climate data to construct their portfolios, this data represents at most 12% of the determinants of portfolio stock weights on average. This low percentage very clearly means that the construction of climate indices remains essentially guided by purely financial considerations.
- To tackle this inconsistency between the stated climate objective and the reality of their investments, the authors suggest that when climate considerations represent less than 50% of the determinants of the weight of the stocks in a portfolio, then this portfolio should be considered to be at significant risk of greenwashing and should not be permitted to claim that it is climate-friendly or aligned with net-zero ambitions.
- The lack of consistency between the evolution of companies’ climate performance and their weights in green portfolios has very negative consequences for the impact of investor engagement on these same companies, and especially on their positive response to the request for a climate alignment plan. As such, we observe that the stylised strategies that represent the vast majority of transition or alignment benchmark offerings see the weight of a highly significant percentage (35% on average) of climate deteriorators (i.e., companies whose climate performance deteriorates) increase over time. This inconsistency between companies’ climate performance and weights in investors’ portfolios removes any credibility from the engagement actions that investors conduct with these same companies.
- It must be recognised that portfolio decarbonisation objectives are often achieved by implementing sector greenwashing. Climate strategies and benchmarks may exhibit strong sector deviations by organising their decarbonisation through a reduction in the capital allocation to sectors with strong climate intensity. An under-representation of sectors that are key not only for growth but also for energy transition would be particularly problematic. Since considerable investment is necessary to ensure electrification of the economy and decarbonisation of electricity, underfunding of this sector in climate-aligned benchmarks, which can correspond to a reduction in capital allocation of up to 91%, would constitute the most dangerous form of portfolio greenwashing.
All popular climate-aligned indices and funds are exposed to this greenwashing risk and unfortunately the recent EU regulation on Paris-Aligned Benchmarks does not protect against this risk. On the basis of these findings, the authors encourage both investors and regulators to reconsider the investment standards and practices in the area of climate alignment.
This study is being presented at two webinars at 10am and 5pm CEST on Tuesday, September 21. To register for one of these webinars, please click on one of the links below:
The morning session (10am CEST) The afternoon session (5pm CEST)
