An analysis of 94 mutual funds and ETFs with ESG (environmental, social, and governance) in their name found that the linguistic patterns in prospectus language have a relatively low correlation with ESG ratings. Based on the research, the report showed that one cannot tell the difference between a prospectus for true ESG vs. greenwashing mutual funds and ETFs.
“Top of the list is standardizing a glossary of ESG terms and a fund classification framework subject to enforcement by the [SEC].”
The final report, titled “Identify ‘Greenwashing’ Funds Using NLP Firms’ Prospectuses” was produced by a team of University of California, San Diego graduate students.
As You Sow, a non-profit shareholder advocacy organization, approached UCSD to oversee the analysis after noticing that of 3,000 mutual funds and ETFs it tracks, 94 had “ESG” in their names yet 60 of those earned a “D” or an “F” on one or more ESG criteria.
They shared the information with the SEC and decided to use analytical science to better understand the state of the ESG-segment of the industry.
“We see funds with ESG in their names getting F’s on our screening tools because they hold dozens of fossil fuel extraction companies and coal-fired utilities,” As You Sow CEO Andrew Behar said in a statement. “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. This will help to eliminate confusion and misleading marketing, fund naming, and prospectus language.”
The UCSD team divided the 94 funds into two groups: 34 “good” funds earning only A, B, or C grades and 60 “bad” funds earning at least one D or F grade, based on As You Sow’s Invest Your Values scorecard. It flags companies in funds along seven issue areas: fossil fuels, deforestation, gender equality, civilian firearms, prison industrial complex, military weapons, and tobacco.
Real or greenwashing?
The analysis extracted key ESG terms including: Carbon, Climate, Divestment, Engagement, Environmental, ESG, Ethical, Exclusions, Fossil, Green, Impact, Integration, Moral, PRI, Religious, Responsible, SDG, Social, SRI, Sustainable, Governance, Alcohol, Gambling, Tobacco, Nuclear, Power, Energy, Thermal, Fuel, Coal, Oil, Gas, Weapons, Waste, Firearms, Ammunition, Minority, Emissions, Diversity, “Gambling, Anti-corruption, Labor, Human rights, and Community.
The analysis also looked at “Wiggle terms” that are often found in prospectus language to make the ESG terms less precise. These included seek, believe, pursue, only, most, help, always, possibly, would, could, used, may, and might.
The team sorted phrases as seen in the table below to look for discernable patterns. Note how the two types of funds are nearly identical.
The analysis also included funds that claimed to be holding non-ESG companies for “engagement” and concluded that some, like Boston Common, used language that was clear while others did not. The report looked at “intent,” noting that “sentences or paragraphs should convey the intent of adding ESG in the investment thesis in the first place and should regard ESG as their core value.”
As You Sow met with the SEC Division of Investment Management on Jan. 6, shared the report, and made recommendations to address the issue of confusing and misleading fund naming and prospectus language.
Top of the list is standardizing a glossary of ESG terms and a fund classification framework subject to enforcement by the agency. They also recommended a requirement 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 spot issues rapidly. Third, they plan to continue the 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% 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.”
The goal is to enable advisors and investors to have assurance and agreement on what an “ESG,” or “fossil-free” fund is. Currently, there are many “fossil-free” funds with significant investments in fossil fuel companies, there are “low carbon transition” funds that hold Exxon, Chevron, and fossil-fired utilities like Duke and Southern.
In December, Bloomberg published a story, “The ESG Mirage” stating that “MSCI, the largest ESG rating company, doesn’t even try to measure the impact of a corporation on the world. It’s all about whether the world might mess with the bottom line.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
It’s not just ESG funds. Virtually ALL mutual funds hold positions outside of their stated strategy. I’ve done hundreds of audits of investment accounts, and almost all of them have this problem. It results in over-diversification, massive overlap, and investors often taking significantly more or less risk than they think.