🔬 The SEC works hard, but fund marketers work harder. Having charged BNY Mellon $1.5M for implying all mutual fund investments had undergone an ESG quality review, the regulator is investigating Goldman Sachs over “at least four funds that have clean-energy or ESG in their names.” Under scrutiny is the tech-heavy GS US Equity ESG Fund, formerly known as a Blue Chip Fund. It was rebranded in 2020, a simpler time. Back then, blue chip was tech, tech was ESG, and ‘doing well’ really was ‘doing good’. You could even say “my definition of ‘doing good’ is ‘doing well’,” and that would be A-OK in the eyes of the SEC, provided you didn’t label as ‘good’ a fund that hadn’t met your definition. That’s where BNY tripped, and GSAM, technically, didn’t? For its International ESG Equity and EM ESG Equity funds, GSAM defines ‘ESG Focus’ as “[seeking] to invest in sustainable businesses.” In the GS US Equity ESG Fund, however, an ‘ESG Focus’ is, apparently, “[seeking] to invest in industry leading, durable franchises.” AKA blue chip. Perhaps lazy in the eyes of one GSAM fund manager, but it’s not miss-selling. Take note, issuers of the 1,096 new ESG strategies since 2019. Particularly if you represent one of the 606 rebranded ones.
🚩 There’s more at stake than a regulatory wrist slap. ESG equity funds are bleeding. Bloomberg Intelligence shows May was a record month for outflows, with ETFs losing an “extreme” $2B. Yes, all funds are suffering. No, ESG was never going to be popular in a recession ruled by eye-watering oil prices. The energy transition isn’t linear, and nor, by definition, are market cycles, so a volatile period wouldn’t be existential—were performance the only problem. Having peddled and profited from the myth that the world can be divided into ‘good’ and ‘bad’, the industry now faces a PR crisis of its own making. Those can be existential and can’t be waived with a $1.5M fee. So, how do you save sustainable finance? Focus on flexibility and communication, says Barron’s. Unexpected developments and mixed signals? It’s called a ‘market’. Case-by-case decisions? It’s called ‘investing’. Time to accept ‘sustainability’ is mutable, depending on economic context and investor opinion. Exclusionary lists don’t represent change. Rigid ratings don’t represent diverse thought. Hey, according to Matt Levine, holding all the oil may, in fact, be the best way for a climate-conscious investor to do well (maximise margins) by doing good (blocking wells).
🚨 Let the regulators focus on the rules. There’s plenty in the pipeline. While the SEC proposes new rules changes to prevent misleading or deceptive claims and increase disclosure requirements, the EU and ISSB are racing ahead with diverging standards for corporate disclosures. Ratings providers are up next. Last week, the European Commission closed the comment period on its consultation for ESG ratings. It comes as a 2° Investing Initiative report reveals over 50% of investors think aggregate ESG ratings should be abolished and over 80% think individual ‘E’ ‘S’ and ‘G’ scores should be unbundled. All this regulation is expected to be headwind for traditional ESG ratings but a tailwind for granular and impact data. About time, too. Last week, a study from Intellidex revealed ESG is a major impediment to flows into developing countries. Because ESG is about mitigating risk rather than achieving impact, investors have underweighted and avoided developing markets due to perceived social and governance flaws and a straightforward lack of data. “It was a surprise to me, to what extent ESG—as it’s practised—is not aligned with the SDGs,” Intellidex co-founder Stuart Theobald told FT Moral Money. (Discover just how misaligned.)
The regulators are coming for ESG. That’s good news if it means fewer funds doing ESG badly. It’s bad news if it means fewer funds doing ESG at all.
Markets might be cyclical, but the principles driving sustainable investing are structural. Climate change could cost $23 trillion per year in 2050. Mitigation and adaptation will cost many trillions more. Given the scale of capital deployment, it’s not a challenge the investment industry can sit out. The long-term risks, and corresponding returns, are both financial and existential.
Too little rulemaking is, evidently, bad, but too much could stymie innovation and investment in climate solutions. Take the SEC’s proposal that funds only be labelled ‘sustainable’ if sustainable factors are weighted higher than financial. Given their legal obligation to act in the financial best interest of their clients, how then does a US adviser choose the sustainable option without inviting a lawsuit? And then there’s the onus on asset managers to detail ever more information and align to yet more rigid parameters, even as their budgets shrink under fee pressure.
A straightforward score or standard is valuable in that it minimises debate, but sometimes those debates are worth having. We’re hardwired to make shortcuts. Easier to focus on Stuart Kirk’s “who cares if Miami is six metres underwater in 100 years?” than his follow up “we spend way too much on mitigation financing and not enough on adaption financing.” The annual cost of adaptation could reach $300B by 2030. While all attention is on mitigation, less than 2% of adaptation finance currently comes from private sources. Surely a more valuable conversation than the outrage on which vats of ink and miles of column inches were, instead, spilled?
SEC chair Gary Gensler has said he wants to make a sustainable fund label as easy to decipher as a ‘fat free’ label on a milk carton. The trouble is, sustainability isn’t fat content. There’s divergence between E and S and G, and there’s divergence in opinion about their relative importance. You can criticise ratings providers for obscuring the former with aggregated scores, but for representing the latter with relative weighting? Not sure.
Util will soon release a report, previewed recently in Bloomberg Green, which shows just how tricky it is to get it right. For each of the 17 SDGs, we surfaced the ten funds that contribute the most positive impact and the ten funds that contribute the most negative impact. Our fund universe comprises every US-domiciled equity fund.
With eight years remaining and tens of trillions needed to achieve the UN Agenda for Sustainable Development, investors need to mobilise capital today—but there’s no catchall solution.
For example, consider SDG 13: Climate action. The ten highest positive contributors to SDG 13 are, as expected, those in clean energy and technology (and insurance, because adaption). No big surprises:
Companies with a positive impact on the environmental SDGs tend to be inoffensive, in that they don’t—by virtue of their products—have a negative impact on the social SDGs. For those with a negative impact on the environmental SDGs, however, it’s more complicated.
The ten highest negative contributors to SDG 13 are mostly utilities funds. Again, not surprising in itself:
But there is a shock in that, against other SDGs, some of the SDG 13 laggards become leaders.
Utilities, and the funds that hold them, are among the top positive contributors towards SDGs 4 (Quality education), 7 (Affordable & clean energy), 8 (Decent work & economic growth), and 9 (Industry, innovation & infrastructure). Even on a single SDG, an industry can have effects both positive and negative. If you look under the bonnet of SDG 7, for instance, utilities are both positive (affordable) and negative (clean).
In his infamous speech, Kirk joked about “the amount of work these people make me do.” As sustainable finance evolves into a sophisticated market, it’s not going to get any easier.