Sustainable investments based on environmental, social and governance (ESG) criteria are the hottest topic in the European investment industry. But as there is no single definition of what an “ESG investment” means exactly, there are many different approaches in the market. The wide range of criteria to select securities that are sustainable from the investment manager’s point of view is confusing for investors and investment advisors. Even the recently introduced Sustainable Financial Disclosure Regulation (SFDR) might not be able to avoid greenwashing. Therefore, there is a lot of responsibility on the shoulders of investment advisors and fund platforms when it comes to fund selection capabilities because investors trust their fund providers to label ESG investments accurately. This means there is a huge reputational risk for the respective investment advisor or fund platform. As a result, it is not surprising that a high number of investment advisors and investment platforms seek help from third-party providers to enable their customers to search for the funds that best fit their needs and/or values. This way, they can avoid the reputational risk coming from misleading advice.
But is it really enough to transfer the responsibility for the fund selection over to a third party to avoid reputational risk? I don’t think so, since an error of the service provider will in a number of cases fall back on the provider who used the respective screening tool. To avoid this kind of reputational risk, the respective provider must do its homework and needs at least to review the list of funds for obvious errors or misleading recommendations.
That said, all investors and market observers should be aware that even the best fund screening models can be misleading if the underlying information—such as the description of the investment strategy of a fund—is wrong or misleading, or if there is a lack of transparency with regard to the disclosure of the holdings in a portfolio.
With regard to the above, the fund industry should review its current standards around the marketing of funds and the use of key words such as environmental, social or governance, etc. in the legal and/or marketing documents to minimize reputational risks. In addition, any self-declaration of the fund industry might avoid that market regulators take further actions, as it is already clear that the European Commission and ESMA will increase the pressure on the fund industry to comply with the sustainability targets of the EU. I could even imagine that European Securities and Markets Authority (ESMA) or a local regulator may start a probe to identify mutual funds that are using key phrases in legal and/or marketing documents, without implementing the respective criteria within their investment process. Any claim from this might bear a reputational risk for the whole fund industry and not only for the promoter who got caught by misusing these terms.
The views expressed are the views of the author, not necessarily those of Lipper or Refinitiv
