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12 Apr 2022

'Sustainable' investment funds falling short of investors' expectations

Investors who want to do good face a minefield choosing an ESG fund

Many investors who hold sustainable funds would be horrified to discover what they're actually invested in, Which? can reveal.

In our survey of Which? members, 58% who held a sustainable investment fund - often referred to as an Environmental, Social and Governance (ESG) fund - thought it invested in companies that aim to create positive change in society or the environment.

In reality, such funds (known as 'impact funds') are relatively uncommon. In fact they held the lowest assets under management of all ESG funds in 2020, according to the Global Sustainable Investment Review.

We've found that investors' savings could instead be going into fossil fuels and even funding deforestation.

With UK investors pouring £16 billion into 'responsible funds' in 2021, the investment industry and regulators need to act quickly to protect conscientious investors from buying funds that fail to live up to their values.

Here we explain why many investment funds don't do what they say on the tin - and how you can find one that does.

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How 'sustainable' are sustainable funds?

With demand for ESG products soaring, fund managers have rushed to cash in. Last year alone, 1,017 new sustainable funds were launched and 536 'rebranded' as sustainable, according to Morningstar.

However, there's no currently no regulation in the UK for what makes a fund 'ESG'. That means fund managers can use the label even if their fund has very flimsy commitments to sustainability - putting people at risk of investing in a fund believing it's 'greener' than it really is.

Take a look at BlackRock's iShares ESG Aware MSCI USA, one of the biggest ESG funds in the world both in terms of assets under management and investor inflows. Among its holdings are fossil fuel giants Chevron and Exxon Mobil.

Meanwhile, Vanguard's ESG Developed World All Cap Equity Index Fund (UK) - which was among the most-bought ESG funds on the platform Interactive Investor in 2021 - invests in McDonald's, Mondelez and Nestle. All three companies have supply chains linked to the destruction of the Amazon rainforest.

Many investors underestimate the likelihood they're exposed to controversial stocks such as these.

The majority of those surveyed - 67% and 66% respectively - were confident they weren't invested in fossil fuels or companies that contribute to deforestation.

BlackRock and Vanguard defend their investments in the likes of Chevron and McDonald's on the grounds that they have committed to net-zero emissions by 2050. So by investing in these companies, the fund managers argue, people can participate in the transition to a green economy.

But is this the ESG strategy most investors prefer? Our research suggests not.

Only 2% said their favoured ESG strategy would be investing in controversial companies to encourage them to become more sustainable.

Misleading labels

Some investors may have misunderstood what their funds invest in because of the way they're branded.

For example, the Vegan Climate exchange traded fund (ETF) may sound like it invests in companies that make vegan products. But it's actually invested in large-cap US stocks that don't exploit animals - including Alphabet, Mastercard and Tesla.

Beyond Investing, which manages the Vegan ETF, said the name isn't misleading because it accurately reflects how it's managed and this is clearly outlined in the fund documents online.

Right now, the onus is on the investor to spot greenwashing in their funds. But wefound few people actually do much research into their ESG funds.

One fifth (21%) were unable to state their ESG fund's investment approach, while 18% admitted they did not try to access information about the fund's ESG strategy before investing.

We found further evidence which suggests that investors do not carry out in depth research of their funds.

For example, investors were more likely to read the Key Investor Information Document (47%) than the prospectus (17%) before investing, despite the prospectus offering more information about the ESG strategy.

Only eight per cent of investors read the annual reports, which are often the only place to find a fund's full holdings listed. And just three per cent of investors looked at reports from Share Action or the fund manager's voting decisions beforehand.

Will regulation improve transparency?

The industry must make it easier for people to invest according to their values.

To this end, the Financial Conduct Authority (FCA) has proposed a series of labels for investment funds:

Not promoted as sustainableResponsible (may have some ESG investments)Transitioning
themes or
low allocation
to Taxonomy-aligned
themes or
high allocation
to Taxonomy-aligned
of delivering
environmental or
social impact)

But standardised definitions alone won't protect investors.

When we presented the labels above to investors, 20% said they didn't understand much of it and 8% said they didn't understand any of it.

Simple, jargon-free language is needed to make sure people understand the differences between ESG investing strategies (as our previous research has shown most don't).

The FCA is also introducing climate-related disclosure rules for asset managers, insurers and pension providers and plans to introduce 'sustainability-related requirements' for financial advisers.

In our survey, two-fifths (40%) of respondents with ESG investments found about them via a financial adviser, demonstrating the important role advisers play in recommending ESG products.

However, only 17% of people said their adviser had initiated discussion about their sustainability preferences, in a separate survey of 4,989 Which? members with a financial adviser carried out in February 2022.

How to pick the right sustainable fund for you

Here are some top tips for making sure you're investing in an ESG fund that really does what it claims:

  • Read the prospectus.This is where the fund manager will outline their ESG strategy. Do they clearly state the investment style, such as 'negative screening', and does that work for you?
  • Look for precise language around industry requirements.Do they specify state their requirements for each industry rather than vaguely saying they take ESG characteristics into account?
  • Look at the team who manages the investment.You may feel more comfortable investing in a company that has a strong history of working on ESG funds.
  • Check their engagement with companies.This will help you determine whether the fund manager has a good history of stewardship. Look at reports from ShareAction or data on the fund manager's voting decisions at annual general meetings.
  • Check the holdings.If there are certain industries you know you'd feel uncomfortable being invested in, then it's worth looking under the bonnet of the fund to check the holdings yourself. You can find these in the fund's annual report or statement, available online.