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 Market Mysteries of the week

  Are these “green” products and “ESG investment” funds really sustainable?

Answer:

Not necessarily. Companies and investment funds often use a marketing strategy called

"greenwashing"

to exaggerate the ‘eco-friendliness’ of their products or practices to mislead consumers and capitalize on the growing demand for sustainable products.

Greenwashed products

Greenwashing can

bring in more sales

, and companies can

market themselves as “green”

without actually taking big strides to reduce their impact. Consumers feel better about buying a product they view as better for the environment, and corporations have taken notice of this. In a global survey, 85% of respondents said they have

shifted their spending habits to be more sustainable

, and one-third of global consumers are

willing to pay more for a product that is sustainable

. As demand for these products increased,

sales of products with sustainable attributes grew

from 19.7% in 2014, to 22.3% in 2017, and were expected to rise to 25% in 2021.

Due to this rise in demand, companies may use

misleading labels

or vague explanations of how their product is “green”, or how it uses some degree of “recycled” materials. For example, Tide’s laundry detergent “

Purclean

,” marketed (below) as “the first plant-based* liquid laundry detergent” says it is made of plant-derived ingredients, free from perfumes, dyes, phosphates, and chlorine. However, Tide was

sued for not adequately disclosing the degree of biobased content or its ingredients that come from petroleum

. It’s

still packaged in plastic and contains chemicals that don’t completely biodegrade

and then potentially contaminate the water supply.

Greenwashed investments

Not only are greenwashing strategies slapped onto labels of products, but they can also be used to attract investors.

Investment firms are capitalizing on investors' increasing desire to lessen our impact

on the planet. Sustainable funds, often referred to as "ESG funds" for their

use of Environmental, Social, & Governance risk metrics

, are growing fast. The number of

ESG funds more than doubled in 2020

from the previous year, accounting for roughly

a quarter of all money that flowed into US stock and bond mutual funds in 2020

.

Sustainable funds

market themselves as investors in companies with sound environmental, social, and governance (ESG) practices, such as companies promoting clean energy or prioritizing women in leadership roles. These funds use ESG ratings to evaluate holistic factors of the company's practices and

brand themselves as better for the environment, society, and governance

. Therefore,

if a company can get better ESG ratings, it can appeal to more investors

and earn more capital.

MSCI, the world's largest provider of ESG ratings, has been measuring the performance and practices of company stocks for decades. Bloomberg estimates that

60% of the money that flowed into ESG funds globally used MSCI's ESG ratings

.

But

ESG ratings aren't necessarily a reliable indicator of how "good" a company is

. Environmental and social risk ratings are not regulated, are inconsistent across rating agencies, and often provide low transparency into the proprietary rating policies. You would think these ratings gauge a company's impact on the world and society, but in fact, the ratings are used to gauge

the impact the world has on a company

and its shareholders. For example, an ESG rating given by MSCI that measures "water stress" looks at whether or not

the community has enough water to supply the company, not whether the company is putting stress on the community's local water supply

.

Let's take a look at McDonald's as another example. The company is the world's largest beef purchaser, and approximately

80% of its total emissions come from its supply chain to source beef, chicken, and dairy

. In 2019, the company was responsible for

54 million tons in emissions

, more than Portugal's total emissions. Despite minimal action to address supply chain emissions, MSCI evaluated McDonald's environmental practices and improved its environmental rating for mitigating waste by installing recycling bins at various locations (most where sanctions are in place if a company

doesn't recycle

). So MSCI's ratings are more concerned with the risk of fines to McDonald's for not recycling than whether it reduces its most significant impacts on the environment.

Are ESG funds the problem?

ESG funds aren't inherently good or bad.

ESG is just another metric system

that evaluates a broader range of operational and exogenous risks, but i

t's now been associated with sustainability and social impact

. So investment fund managers

can drive more inflows

and get more attention by mentioning that they're using these holistic metrics,

even if they aren't driving their investment decisions

. To our earlier water stress example, a fund manager might use that ESG metric to evaluate how limited resources affect a company's success, but that doesn't mean they're necessarily investing in companies that are limiting their negative impact.

What should I do?

Always remember that you're investing in companies

. No single company is perfect, nor does any represent a singular social or environmental value. Be wary of marketing spins and make sure you understand where your money is going.

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