Around the world, investment firms, corporations and governments are scrambling to respond to calls for increased climate action and societal justice with pledges to measure everything against an environmental, social and governance (ESG) yardstick. But in the ESG stampede, insiders warn that too many stocks are getting tossed into green funds without enough oversight.

There have been grumblings about “greenwash” in the sector for years, but Tariq Fancy turned it up to 11, so to speak, when the former chief investment officer for sustainable investing at BlackRock (the world’s largest asset manager), raked the industry over the coals in a March op-ed.

“Wall Street is greenwashing the economic system and, in the process, creating a deadly distraction. I should know; I was at the heart of it,” Fancy wrote in USA Today. In many instances, “existing mutual funds are cynically rebranded as ‘green’ – with no discernible change to the fund itself or its underlying strategies – simply for the sake of appearances and marketing purposes. In other cases, ESG products contain irresponsible companies.”

His charges were damning, but they weren’t news to those paying attention. Last year, UK-based ShareAction examined 75 of the most influential asset managers worldwide and concluded that “50 have a very limited approach to managing ESG risks, receiving either a D or E rating.” Though a third ranked higher than a B (BMO and HSBC Global Asset Management earned Bs, while RBC and Manulife scored Cs), BlackRock, tellingly, was slapped with a D.

Nonetheless, Hugh Wheelan, co-founder of Responsible Investor, says that Fancy is only partly right. “Do we face swathes of greenwash in ESG statements, fund compositions and company ‘assessments’? Yes, with caveats. Little of what goes into environmental funds is 100% green (nothing is), and ESG is not a science.” Still, he urged the public to reject easy cynicism and remain committed: “Now is the time to hold fund managers to account.”

At the heart of the problem is the lack of agreed-upon standards for qualifying for, say, an “ESG-aligned” investment fund. Though that’s starting to change. In March, the U.S. Securities and Exchange Commission announced a new Climate and ESG Task Force in its enforcement division, tasked with “proactively identifying ESG-related misconduct.” Across the pond, the EU’s new rules designed to stamp out ESG-fund greenwashing take effect in June.

Debate rages over whether that green taxonomy is too watered down or too tough to support higher-carbon companies as they transition to net-zero. Mark Carney’s take: “We don’t just need brown/green; we need 50 shades of green and we need a way to communicate more precisely.”

Most agree with Fancy about one thing: “We’re running out of time and need to accept the truth: To fix our system and curb a growing [climate] disaster, we need government to fix the rules.” Or rather, we need to turn up the pressure on government to fix the rules.

Fund spotlight:

BlackRock iShares MSCI ACWI Low Carbon Target ETF (CRBN)

What’s promised: This ETF “seeks to track the investment results of an index [composed of companies] with a lower carbon exposure than that of the broad market,” giving investors “exposure to a broad range of global stocks that are less dependent on fossil fuels.”

What’s inside: Traditional ethical investors might gasp when they see 15 makers of controversial weapons, including Lockheed Martin, nestled in this portfolio. Turns out even the world’s largest maker of bombs, missiles, fighter jets and nuclear subs has developed a low-carbon transition plan (net-zero thermonuclear warheads, anyone?).
Even if you generously assume the same holds true for the handful of for-profit prisons, harmful pesticide-makers and mining firms tied to severe environmental damage in this ETF’s portfolio, low-carbon purists will no doubt take issue with some of the fund’s most climate-contentious holdings, including:

• 6 thermal coal-burning companies
• 11 climate-policy-
blocking companies, including Berkshire Hathaway and Chevron
• 4 deforestation and palm oil laggards linked to clearcuts in the Amazon rainforest and Southeast Asia (deforestation is a primary contributor to climate change), and
• 6 industrial meat companies, including Tyson Foods, America’s largest beef, pork and poultry processor (animal agriculture is a significant contributor to climate change).

BlackRock’s position: BlackRock says the ETF’s MSCI weighted average carbon intensity (tons CO2e/$M sales) is just 64.74, significantly lower than the 178.5 average for benchmark MSCI ACWI Index. Whether that will convince climate-conscious investors that this fund deserves their attention remains to be seen.

Adria Vasil is the managing editor of Corporate Knights. She’s also the author of the bestselling Ecoholic book series.

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The COVID-19 crash came on suddenly. Investors panicked when they realized the severity of the situation, and there was talk that we could be headed into a depression. Central banks including the Bank of Canada and the U.S. Federal Reserve stepped in quickly, providing liquidity to prevent the bond market from collapsing. Many of us were afraid that it would be a repeat of the 2008/09 crash, when sustainability got thrown on the backburner. Fortunately, it feels like this time is different, as leading economies around the globe are baking social and environmental concerns into their economic recovery strategies.

It’s fair to assume that more of that baking lies ahead in Canada, with the appointment of impact investing maven Michael Sabia as deputy finance minister in November. The Canadian government is also in the midst of creating a Sustainable Finance Action Council to help ratchet up action on that front, and the Bank of Canada is launching a pilot project with major banks and insurance companies to assess and understand climate risk.

South of the border, things are looking even more optimistic. After four years of a White House that dismissed climate science, we’re seeing an administration that actually treats climate change like the crisis it is. The nomination of Janet Yellen to the role of Treasury secretary is encouraging, since she just co-chaired the G30 Working Group on Climate Change and Finance with Mark Carney, former governor of the Bank of Canada. Yellen has made her position clear: “Carbon must be priced appropriately to internalize the costs of polluting the planet.” A carbon tax in the U.S. would be a catalyst for further sustainable investment gains.

Sustainable investors are happy right now. According to the most recent report from the Responsible Investment Association, 80% of responsible investment funds have outperformed the average of their asset classes this year. The biggest winners have been the “doing more good” funds that invest in sustainability themes like cleantech and renewable energy. Electric car shares have been particularly impressive, with Tesla up eightfold (it’s now worth two and a half times more than ExxonMobil) and Chinese EV maker NIO up 20-fold.

Investors should be cautious since it’s unlikely that green sectors will continue to grow at such a rapid pace, but it does indicate markets have accepted that a green transition is underway and explains why sustainable investments have performed so well.

In addition to terrific financial performance, we’ve also seen the sustainable investment ecosystem mature considerably. Corporations are tripping over each other pledging to be net-zero by 2050, and 2020 saw the launch of a record number of new sustainable investment funds, including new exchange-traded funds (ETFs) from BMO, BlackRock and Wealthsimple. Sustainable investors now have more choice than ever, and demand is growing. A global report from Morningstar shows that more than US$347 billion poured into sustainable funds in 2020, eclipsing 2019’s record $160 billion of inflows. Much of that growth was in Europe, but in Canada, 41 new sustainable funds and ETFs were launched in 2020 alone, more than double 2019.

According to the 2020 RIA Investor Opinion Survey, 75% of respondents want their financial services provider to show them sustainable investment options, but only 28% of respondents have been asked if they are interested. For those of you who have been dragging your feet on switching your investments, consider this a kick in the butt to get it done ASAP. Almost every bank and financial advisor now has sustainable investment products on the shelf, and the myth that sustainable investments underperform financially has been thoroughly busted. If your advisor isn’t up to speed on these options, it’s time to find a new advisor (RIA has a marketplace for investment advice) or explore do-it-yourself investing. I’m hopeful that the 2021 Eco-Fund Ranking will be a helpful resource as you evaluate the options and decide which approach is right for you.

Tim Nash is the founder of Good Investing.

Corporate Knights ranked more than 1,000 mutual funds and ETFs based on their financial and sustainability performance and ESG-aligned management commitments.

Here are the top scorers.

Methodology: Funds are scored according to 1) three-year net return percentile rank (50%), 2) weighted sustainability rating percentile rank based on analysis of their holdings (40%), and 3) fund-manager intention to manage the fund according to responsible guidelines (10%). If the fund is less than three years old, its final score is based on #2 and #3, which are grossed up proportionately to 100%. Funds that do not have an ESG mandate or are not operated according to responsible guidelines are automatically excluded from the ratings. Funds that score in the highest or second-highest quintile among category peers receive a five-tree or four-tree rating respectively.

* Holdings that are red-flagged automatically receive a 0% CK Sustainability Rating Score. Red-flag holdings include companies that are classified in the Corporate Knights database for one or more of the following criteria: access-to nutrition laggards, access-to-medicine laggards, adult entertainment, companies blocking climate policy, cement-carbon laggards, civilian firearms, controversial and conventional weapons, deforestation and palm-oil laggards, fossil fuels (energy), farm-animal-welfare laggards, for-profit prisons, gambling, gross corruption violations, harmful pesticides, illegal activity, oil sands laggards, severe environmental damage, severe human rights violations, thermal coal, tobacco, alcohol, companies blocking climate resolutions, companies financing misleading media, industrial meat, nuclear energy, and companies most exposed to ESG and business-conduct risks.

Sources: Corporate Knights Research, Fundata, Responsible Investment Association, Refinitiv, InfluenceMap, Norges Bank Investment Management (NBIM), Chain Reaction, NZ Super Fund, Stockholm International Peace Research Institute, American Friends Service Committee, Access to Nutrition Initiative, Access to Medicine Initiative, Motley Fool, animal welfare experts, Unearthed, Urgewald/GCEL, Media Matters, MVIS, RepRisk

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For most, the default setting is to walk into their bank, buy mutual funds, and walk out as quickly as possible. The problem is that people rarely have any idea how much they’re paying in fees and they have no clue what companies are inside those funds.

That’s why the new trend is to purchase exchange-traded funds (ETFs) that have much lower fees and are much more transparent than mutual funds, making it easier for Canadians to invest with their values.

ETFs have surged in popularity over the last decade. What started as a niche offering for do-it-yourself investors has now become the most popular investment vehicle in Canada. ETFs represent about 11 per cent of the almost $2 trillion that Canadians have invested, but Canadian ETFs attracted a record $30 billion in 2019, outpacing the sale of mutual funds, according to the Canadian ETF Association.

While there were only a few sustainable ETFs a decade ago, the industry is evolving, and more sustainable ETFs are coming out every year.

Following RBC’s launch of six sustainability-themed iShares ETFs in 2019, BMO joined in this January, by releasing a new lineup of eight sustainable ETFs called ESG ETFs into the Canadian marketplace.

The two most popular strategies for responsible investors are sector exclusion (often called divestment) and the integration of environmental, social and governance (ESG) data.

Historically, responsible investing was heavily influenced by the Mennonite community in Canada, which meant that the most typical ethical fund exclusions were “sin sectors” like tobacco, alcohol, gambling and weapons.

In recent years, environmentalists started calling for investors to divest from fossil fuels; there is lots of momentum behind this movement. ESG integration is a little more nuanced, with companies being graded on their promises, policies and performance regarding ESG issues.

One critique of ESG integration is that it doesn’t consider the product or service the company is selling, which is why it should really be used alongside sector exclusion.

Nonetheless, BMO’s new ESG ETFs are impressive. The funds exclude tobacco, alcohol, gambling, conventional weapons and civilian firearms, any controversial weapons, as well as companies involved in severe controversies.

Additionally, by following the MSCI ESG Leaders Index methodology, they are employing one of the strongest ESG integration definitions I’ve seen among Canadian ETFs. Companies are ranked by ESG rating and the funds include roughly the top half of companies within each sector.

This methodology means that sector breakdowns will be the same as traditional ETFs but with only about half of the number of companies — those with the highest ESG scores.

Investors who want to divest from fossil fuels will be disappointed in the Canadian equity offering since oil, gas and pipelines are still included. For example, Suncor and Enbridge make up a combined 15 per cent of the BMO MSCI Canada ESG Leaders Index ETF (ESGA). Suncor and Enbridge both have decent ESG ratings, which is why they are still included in the fund.

Otherwise, their “all-in-one” ETFs make life easier for sustainable investors. For example, the BMO MSCI Global ESG Leaders Index ETF (ESG) is a combination of their Canadian, U.S. and Europe/Australia/Japan funds, while the BMO Balanced ESG ETF (ZESG) takes this global diversification and adds in Canadian bonds to create a balanced portfolio. This “all-in-one” approach is popular among traditional investors, so I’m thrilled to have it as an option for sustainable investors.

On the fee front, Canadians pay some of the highest investment fees in the world. The average mutual fund Management Expense Ratio (MER) is about 2.25 per cent. ETFs, by comparison, have an average MER of about 0.3 per cent and the BMO ESG ETFs have MERs that even lower, at 0.17–0.22 per cent, continuing the downward trend of management fees.

Tim Nash blogs as The Sustainable Economist and is the founder of Good Investing.

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Nevertheless, sustainable or responsible investing (whichever term you prefer) has hit the big-time, particularly around the theme of climate change.

Michael Baldinger, head of impact investing at UBS wealth management, which manages more than US$4 trillion in assets, claims that sustainable investing is now the fastest-growing asset class at scale in the world.

It’s hard to argue with the numbers. The Global Sustainable Investment Alliance says there is a US$30 trillion pot of sustainable investments across various themes as of 2018, growing at about 12% per year. A lot of that growth is coming from pension funds and other institutional investors signed up to the UN-backed Principles for Responsible Investment, whose members control US$86 trillion.

Financial markets are driven by two powerful emotions: greed and fear.
As the outgoing governor of the Bank of England, Mark Carney, puts it, “Companies that don’t adapt [to the low-carbon economy] – including companies in the financial system – will go bankrupt without question. [But] there will be great fortunes made along this path aligned with what society wants.”

To wit: the top five coal companies in the U.S. have all declared bankruptcy since 2016, and Apple is now bigger than all the oil and gas companies on the S&P 500 combined, in large part because they have earned negative returns over the last decade, even after accounting for dividends.

Carbon-intensive companies are suffering because the alternatives are not just cleaner but cheaper. Renewables are now cheaper than coal in two-thirds of the world’s countries, according to Bloomberg New Energy Finance. BNP Paribas estimates that oil needs to come down to US$10 a barrel to be competitive with electricity-driven transport. This does not mean fossil fuels are going away tomorrow, but it does kill the growth story. For oil investors, the market’s realization of this inevitable decline could make the coal horror show look like Bambi.

This increasing speed of the energy transition is part of the reason why investors representing US$11 trillion in assets have made public their plans to divest from fossil fuels.

Perhaps more telling is that beyond these public declarations, many of the biggest investors in the world are selling off their fossil fuel holdings and loading up on green assets. For example, without any fanfare the $200 billion Ontario Teachers’ Pension Plan has dialed down its fossil-fuel equity holdings to just 1%. On the upside, the $306 billion Caisse de dépôt et placement du Québec (CDPQ) has grown its green investment book to $30 billion, earning commercial returns along the way, according to outgoing chief executive Michael Sabia.

Just in case anyone was in doubt whether sustainable investing is really about making money, the vampire squid of investment banking, Goldman Sachs, showed up this December pledging US$750 billion in financing over the next decade to profit from the climate transition and inclusive growth.

While economics are shifting in favour of sustainable investing, so is public sentiment. Call it the Greta effect if you like, but most people are no longer comfortable with the idea that their retirement investments may be helping to set the world on fire.

Andreas Utermann, chief executive of Allianz Global Investors, which manages US$600 billion, says, “Clients have changed their tune. They have said we need to take this more seriously, and that has sharpened the minds of asset managers.”

Despite all this action among big investors, it appears small investors are getting left behind. If you add up the assets of the 130 funds on offer in Canada that declare sustainability intentions in their official documents, it is less than 1% ($12 billion) of total fund investments ($1.6 trillion). That’s an even smaller fraction than they were at in 2003, when Corporate Knights published its first guide for responsible investors. What gives?

It boils down to a belief many people still hold that sustainable investing is about sacrificing returns. The theory is that investing to make a return is hard enough, and if you add social and environmental considerations into the mix you are at a disadvantage. The trouble with this theory is that investing is like hitting a curveball, which is a pretty good metaphor for the world we live in. Putting on a sustainability lens gives the batter a better sense of the ball’s trajectory and increases the chance of making solid contact.

To make things easier, Corporate Knights scores all the equity mutual funds and ETFs available in Canada according to how well their holdings line up with established sustainability criteria and, where available, their three-year financial performance record. While we’re not promising any home runs, the 36 funds listed below were deemed the worthiest for taking a swing at.

Eco-Fund Methodology

Funds are scored according to (1) three-year net return percentile rank (50%), (2) weighted sustainability rating percentile rank based on analysis of their holdings* (40%), and (3) fund manager intention to manage the fund according to responsible guidelines (10%). If the fund is less than three years old, its final score is based on #2 and #3, which are grossed up proportionately to 100%. Funds that score in the highest or second-highest quintile among category peers receive a five-tree or four-tree rating respectively.

* Holdings that are red-flagged automatically receive a 0% CK Sustainability Rating Score. Red-flag holdings include companies that are classified in the Corporate Knights database for one or more of the following criteria: companies blocking climate policy, farm animal welfare laggards, companies causing severe environmental damage, companies causing deforestation, forced and/or child labour, severe human rights violations, illegal activity, controversial and conventional weapons, civilian firearms, tobacco, thermal coal, for-profit prisons, access to nutrition laggards, access to medicine laggards, digital rights laggards, investor climate laggards and gross corruption violations.

Sources: Corporate Knights Research, Fundata, Responsible Investment Association, Refinitiv, InfluenceMap, Business Benchmark on Farm Animal Welfare (BBFAW), Norges Bank Investment Management (NBIM), Chain Reaction, Know the Chain, NZ Super Fund, Stockholm International Peace Research Institute, American Friends Service Committee, Access to Nutrition Initiative, Access to Medicine Initiative and Ranking Digital Rights.

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