Responsible investment or greenwashing: how to tell the difference?

Socially respons­ible invest­ment (SRI), which was still rel­at­ively unknown until the early 2000s, con­sists of tak­ing non-fin­an­cial cri­ter­ia, such as envir­on­ment­al, social and gov­ernance (ESG), into account in the invest­ment eval­u­ation process. 

In 2021, 96% of the 250 largest mul­tina­tion­al com­pan­ies on the Fortune500 list (up from 64% in 2005) have dis­closed their ESG policy. Sim­il­arly, nearly 4,400 investors and 50 ser­vice pro­viders, rep­res­ent­ing more than $120 tril­lion in assets, have signed a com­mit­ment to integ­rate ESG inform­a­tion into their invest­ment decisions¹².

But when it comes to defin­ing ESG stand­ards, dif­fer­ences of opin­ion abound, and cri­ti­cism is rife. Elon Musk, for example, called ESG “a scam” and denounced “fake social justice war­ri­ors” after Tesla was removed from the S&P 500 ESG index – for reas­ons related to dis­crim­in­a­tion and work­ing con­di­tions – while Exxon­Mobil remained in the index⁴. Bey­ond the con­tro­versy, a fun­da­ment­al ques­tion about SRI and its true impact on soci­ety is emerging.

There is noth­ing eth­ic­ally wrong with run­ning a busi­ness to make a profit while ensur­ing that pro­duc­tion is socially respons­ible. But impact invest­ing is about more than just ESG-based risk mit­ig­a­tion. It is about sup­port­ing com­pan­ies that are com­mit­ted to pro­act­ively mak­ing a dif­fer­ence, and thus demon­strat­ing that you have indeed been able to make a dif­fer­ence on a num­ber of levels.

His­tor­ic­ally, the first “eth­ic­al” funds were born in the United States. Based on the exclu­sion of com­pan­ies linked to the alco­hol, tobacco, arms, por­no­graphy or gambling sec­tors, the aim was to meet the require­ments of cer­tain investors, includ­ing reli­gious organ­isa­tions. Pos­it­ive approach funds appeared in the 1970s in the United States and in the 1990s in Europe: these sus­tain­ab­il­ity funds con­sider extra-fin­an­cial cri­ter­ia to pro­mote long-term per­form­ance and sus­tain­able growth. More recently, it is not­ably the Par­is cli­mate agree­ment signed in 2015, the res­ult­ing reg­u­la­tions and the aware­ness of cli­mate risk by major fin­an­cial play­ers that are con­trib­ut­ing to the devel­op­ment of SRI⁶.

SRI strategies vary con­sid­er­ably: norm­at­ive or sec­tor­al exclu­sions (com­pan­ies engaged in activ­it­ies that con­tra­dict norms or in activ­it­ies deemed harm­ful), the so-called “best-in-class” approach (invest­ment in the best-per­form­ing com­pan­ies in a giv­en sec­tor), “best-in-uni­verse” (invest­ment in the best-per­form­ing com­pan­ies regard­less of sec­tor), “best-effort” (best improve­ment in ESG prac­tices), and them­at­ic (e.g. “renew­able energies”).

Impact invest­ment is defined by act­ive strategies seek­ing a strong extra-fin­an­cial return based on three key prin­ciples: inten­tion­al­ity, i.e. the investor’s inten­tion­al desire to gen­er­ate a pos­it­ive social or envir­on­ment­al impact, addi­tion­al­ity (the investor’s spe­cif­ic con­tri­bu­tion, fin­an­cial or oth­er­wise, enabling the com­pany to increase its pos­it­ive impact), and impact meas­ure­ment, i.e. the eval­u­ation of the pos­it­ive and neg­at­ive extern­al­it­ies of the inves­ted struc­ture⁸.

Until a few years ago, impact invest­ment funds would have been the only investors to carry out an impact ana­lys­is: this is no longer the case, as socially respons­ible investors (SRIs) now aim to demon­strate their con­crete impact.

How­ever, the two types of investors (SRI vs. impact) have fun­da­ment­ally dif­fer­ent levels of com­mit­ment and dif­fer­ent meth­ods of assess­ment. SRI investors typ­ic­ally invest in lis­ted mul­tina­tion­al com­pan­ies and focus their non-fin­an­cial efforts on the pro­cess of select­ing issuers, rather than on the res­ults achieved through their invest­ments. For example, while an impact invest­ment fund will aim to demon­strate the car­bon reduc­tion achieved through the fin­an­cing of wind tur­bines, an SRI fund will cal­cu­late the car­bon ‘score’ of the com­pan­ies in its portfolio. 

Finally, SRI and con­ven­tion­al port­fo­li­os tend to be very sim­il­ar, and the prac­tic­al impacts of SRI seem very lim­ited to a grow­ing num­ber of research­ers. It remains dif­fi­cult to ima­gine how an investor hold­ing a tiny per­cent­age of a large com­pany’s shares could prove that their invest­ment makes a dif­fer­ence – how­ever well-inten­tioned. Using tra­di­tion­al impact ter­min­o­logy super­fi­cially is there­fore far from help­ful to the SRI com­munity and may even be akin to gre­en­wash­ing⁹.

In a recent study on the con­fu­sion between impact and SRI, we show that although SRI investors are appro­pri­at­ing the vocab­u­lary of impact assess­ment, they are not adopt­ing its prac­tices. How­ever, giv­en the mar­ket power of SRI com­pared to impact invest­ing (about 40 times lar­ger), the appro­pri­ation of impact ana­lys­is by SRI funds is not without con­sequences: the dif­fu­sion of impact meas­ures in the SRI industry can either sup­port the devel­op­ment of impact invest­ing or threaten its mean­ing and legit­im­acy by con­fus­ing the two practices.

Sim­il­arly, while the SRI industry is genu­inely aim­ing to com­bat gre­en­wash­ing, the motiv­a­tions of invest­ment man­agers vary, with dif­fer­ent levels of com­mit­ment to the soci­et­al dimen­sion of impact. SRI investors there­fore face many chal­lenges in mov­ing bey­ond ESG integ­ra­tion to true impact. ESG integ­ra­tion seeks to meas­ure the impact of vari­ous factors on a com­pany’s fin­an­cial flows: the mater­i­al­ity of a factor is there­fore trans­lated into a vari­ation in the com­pany’s turnover, expenses, or invest­ments. In con­trast, impact invest­ing, and more gen­er­ally impact meas­ure­ment, seeks to meas­ure the impact of the com­pany’s activ­it­ies on ESG issues, inde­pend­ently of the fin­an­cial mater­i­al­ity for the company.