New academic research reveals a shocking truth about climate change ETFs and their efficiency in combating climate change. The research shows the climate investment funds dedicated to supporting the green economy are actually routinely engaging in greenwashing, undermining the battle against global warming.
They are even found to starve sectors at the heart of the transition by increasing the weight of companies whose environmental score is diminishing. The research is called Doing Good or Feeling Good? Detecting Greenwashing in Climate Investing, conducted by the French business school and think-tank Edhec.
It analyses Europe-listed ETFs issued by managers like Amundi, BNP Paribas, BlackRock, HSBC and DWS Xtrackers, based on indices from groups such as MSCI, FTSE Russell and S&P Dow Jones- all of them committed to help the fight against climate change.
Climate Change ETF Failure
One of the main findings is that 35% of companies with worsening environmental performance are rewarded with an increase in weight. According to Felix Goltz, co-author of the paper, that figure is supposed to be zero.
The divergence happens as the companies are not penalized as long as they do not go below a defined lower bound in environmental, social, and governance (ESG) scoring and their performance can theoretically drift downwards to a certain degree without consequence. Mr. Goltz also criticized this event as a lack of “common-sense rules” that could prevent it from happening.
“Climate strategies, just like business-as-usual strategies, are mostly influenced by the market capitalization of stocks. The climate score plays second fiddle at best…This demonstrates the dominance that these indices have in the investment management industry,” Goltz added.
That could also draw the conclusion that a climate change ETF can reflect the current structure of cap-weighted indices but it is not necessarily aligned with climate change objectives and goals.
Another finding from the research is that an underfunding exists in the sector of electrification of the economy in climate-aligned pathways and decarbonization of electricity explained by lower investors’ demand. The paper is showing a reduction in the capital allocation of up to 91% – a tendency considered the most dangerous form of portfolio greenwashing.
Lack of clarity in the sustainable classes of funds within the EU’s Sustainable Finance Disclosure Regulation (SFDR) is also tempting asset managers “to reach into their make-up bag and apply the green lipstick a little too liberally across their ranges”, according to the paper.
All of these practices in contradiction with climate change objectives could also be explained by the infrastructure of climate change investment being still at its formative stage and investors susceptible to the “pragmatic” approach that is based on the notion that perfection cannot be fully achieved and it should not stay in the way of progress, as concluded by the research.
A climate change ETF is supposed to be a catalyst of change towards a greener economy for the financial investment world. Therefore, rigorous climate change policies and rules need to apply for the sector to avoid greenwashing examples, threatening to sabotage what they were created for in the first place – to foster climate actions.