Funds representing roughly US$1 trillion in assets aren't delivering on their stated environmental, social or governance (ESG) goals, according to one of the main researchers tracking the market.
A forensic analysis of the industry resulted in the ESG tag being removed from more than 1 200 funds, or roughly one in five, according to Morningstar's classification system. The findings feed into concerns that asset managers are still making misleading claims on the extent to which their allocations are doing the planet or its inhabitants any good.
Hortense Bioy, global head of sustainability research at Morningstar, told Bloomberg that sustainability tags were taken off "funds that say they consider ESG factors in the investment process, but that don't integrate them in a determinative way for their investment selection."
Bioy said funds that used "light or ambiguous ESG language" were targeted in the purge.
The correction marks something of a line in the sand for an investment trend that has enjoyed stratospheric growth, much of which took place before regulations were in place. It also offers a glimpse of the scale of potential greenwashing as the ESG label goes from niche to mainstream.
While Morningstar's definitions don't reflect the way fund managers themselves market their products, there are signs the industry is also capable of self-correcting. Before the 2021 introduction of Europe's anti-greenwash rulebook -- the Sustainable Finance Disclosure Regulation (SFDR) -- asset managers in the region removed the ESG label from $2 trillion worth of funds, according to the Global Sustainable Investment Alliance (GSIA).
Morningstar says it expects its analysts to catch more funds that don't merit an ESG tag as they continue to examine industry data.
Estimating the scope of the ESG market remains difficult. Bloomberg Intelligence and GSIA both put the global ESG market for all ESG assets at around $40 trillion, and see it rising to $50 trillion by 2025. Morningstar says the figure for ESG funds is just $2.7 trillion.
Morningstar's calculations suggest that vast sums of money have been mis-allocated, hobbling efforts to fight global warming and inequality. The numbers also indicate that a sizeable group of investment managers may be vulnerable to regulatory reprimands.
SFDR was designed to ferret out asset managers' inflated ESG claims. The disclosure regulation requires firms to classify their investment products under one of three categories: Article 6, which address ESG risks; Article 8, which promotes ESG characteristics; and Article 9, which sets measurable ESG objectives that have to be met.
Bioy said that the "vast majority" funds that were axed from Morningstar's ESG list were Article 8. "Some asset managers are opting for a softer approach than others," she said.
There are currently about $4.05 trillion in assets being classified by the industry as Article 8 or Article 9 funds, Morningstar estimates. But the "lack of policy guidance" on how to define Article 8 funds has created "confusion and greenwashing concerns," it said in a recent report.
European authorities have acknowledged that there's a need to revisit some of the definitions currently guiding SFDR allocations. The European Commission said in October it is planning to introduce minimum standards for Article 8 funds in an effort to fight greenwashing.
The goal is "to create a baseline for sustainability performance when sustainability claims are being made," Elodie Feller, sustainable finance policy officer at the commission, said at the time. "We see a lot of confusion in the market."
For now, there's still "an unexpectedly high number and broad range of products labeled Article 8 and Article 9," Bioy said. The question is how long that will last.
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