The inconvenient truth about responsible investing: An FP investigation
The rise of responsible investing has been one of the biggest trends to emerge in the financial world over the past half decade, with hundreds of funds now bearing the ESG imprint, signalling that they incorporate environmental, social and governance principles into their investing processes.
According to the Responsible Investment Association, a Canadian industry-funded organization that champions the cause, responsible investing has swept up more than $2.13 trillion in AUM in Canada alone and now covers more than fifty per cent of the total assets that are professionally managed here.
But for investors hoping to see their ethical beliefs — especially when it comes to the environment and climate change — reflected in their portfolios, the contents of a responsible investing fund can come as a shock.
A Financial Post analysis of the 122 active responsible investing funds listed on the RIA’s website found that 45 per cent still had exposure to at least one stock that is primarily engaged in the production, processing or direct transport of fossil fuels. That number is likely conservative because more than 50 of the funds on the list, which includes ETFs, mutual funds, pooled funds, GICs, segregated funds and private funds, only disclosed their top holdings, which made up as little as seven per cent of a portfolio. An additional 18 do not disclose any information about their funds at all.
The holdings the Post was able to access reveal that several funds are invested in stocks such as Enbridge Inc. and Cenovus Energy Inc. in Canada and Exxon Mobil Corp. and BP Plc outside of it. Many are also invested in a host of mining and utilities companies, both of which are heavily reliant on fossil fuels. Tobacco and alcohol stocks also found their way into some products on the RIA’s list, which includes most of the responsible investing funds available in Canada.
In some cases, the funds containing fossil fuels made no specific claims about their fossil fuel holdings and only exclude sectors such as tobacco or gambling. In other cases, the apparent disconnects were more blatant, with the funds advertising themselves as “low CO2” or bearing the initials “ESG.”
“I would consider it greenwashing — they try to get that halo of responsible investing without doing the work,” said Tim Nash, the founder of financial planning firm Good Investing, of those who play both sides of the fence.
I would consider it greenwashing — they try to get that halo of responsible investing without doing the work
Up until earlier this month, many of these funds were also represented inaccurately on the website of the RIA, which describes itself as non-profit educator and advocate for responsible investing in Canada. For each fund, the RIA lists the “negative screens” that apply — meaning those sectors that are entirely eliminated from the portfolio, information an investor might only be able to track down by digging through several hundred pages in a prospectus.
An entire suite of Desjardins ETFs were represented as having negatively screened for fossil fuels, nuclear energy, conflict zones and oppressive regimes when each of the seven funds carried multiple examples of these companies. The Post also found the website indicated funds from AGF, Russell Investments and CIBC Wood Gundy screened for fossil fuels when they each had oil and gas stocks in their portfolios.
When contacted by the Post, RIA CEO Dustyn Lanz said he was unaware the funds were mislabelled online and quickly had their descriptions altered. Lanz said in an email that the faulty information was a result of “data entry errors.”
To be listed on the RIA’s website, organizations need to sign up for membership and pay yearly fees ranging from $1,000 to $20,000. Their products must be marketed as responsible investing funds and each firm needs to disclose the details of their strategy in investment documents.
Desjardins and other fund providers told the Post they were the ones who were responsible for checking off the information about how to represent their funds in an application to be listed on the RIA’s website.
Lanz was adamant that the RIA is not a regulator in the space. It doesn’t “certify or rate products,” he said. Instead, the association’s role is to “promote education and awareness about responsible investing.”
After the Post’s inquiry, however, multiple fund providers said the RIA contacted them because it was performing an audit and wanted to verify that the details listed online for each fund were accurate. Some emails went as far as asking fund providers to point to where their prospectuses say they screen for a certain sector.
“I think it’s absolutely essential that responsible investment funds are doing what they say they’re doing,” Lanz said.
“There is no place for misleading investors in our industry. Those that fail to live up to their claims will rightly be punished by the market.”
There is no place for misleading investors in our industry. Those that fail to live up to their claims will rightly be punished by the market
RIA CEO Dustyn Lanz
How these funds wind up holding stocks that many investors assume they are shunning, appears to be partly a result of the evolution of the industry.
Responsible investing initially focused on eliminating controversial sectors — gambling, alcohol, cigarettes and weapons — to meet the ethical guidelines of faith-based investors who opposed them. As these funds began to appeal to both retail and institutional investors, the umbrella of responsible investing widened.
Currently, there is no one-size-fits-all definition of a responsible investing fund, nor is there an official body regulating the use of the term. If funds choose to use the designation, they must follow any guidelines they create for themselves in their prospectus documents. They make their own rules and can choose how strict they want their portfolios to be.
The RIA says there are multiple responsible investing strategies that firms can choose to implement, and that most funds incorporate more than one into their portfolios.
While negative screening remain a popular approach, the most widely adapted strategy, by far, involves so-called “ESG integration.” To qualify, the RIA says, fund managers must use ESG data alongside traditional metrics when valuing companies, especially in the long-term. Notably, integration does not rule out investing in any particular sector of company. More than $1.9 trillion of the $2.13 trillion in AUM claims to follow ESG integration, some as their only strategy.
Positive screening involves investing only in a sector’s best in-class names. Index providers such as MSCI rank companies based on their implementation of these principles and fund managers will build out a pool of the top stocks in each sector. This method does not result in exclusions by the sector, leaving fund managers open to owning the top 20th to 50th percentile of oil and gas stocks.
There are some funds that buy the same securities that a non-responsible investing fund would, and say they’ll use their power as shareholders to pressure companies into adapting those principles.
A fourth type of fund focuses on thematic investing and is made up entirely of clean technology companies or those with women in leadership.
Should a fund use any one of these strategies, its AUM is counted by the RIA and lumped into the $2.13 trillion total for Canada. It’s a gaudy number, but the mostly retail-oriented funds that disclose their assets and are listed on the advocate’s website only account for about $24 billion of that total. The bulk of responsible investing assets are attributed to pension funds, such as the Canada Pension Plan Investment Board, whose approximately $400 billion in assets makes up about 20 per cent of the total.
The rapid growth of responsible investing is thus not primarily the result of investors pumping money into responsible investing funds; rather, as the RIA’s 2018 report notes, “It is the result of large asset management firms implementing an ESG integration strategy across all of their assets.”
For fund managers and index providers, many of whom stress that eliminating entire sectors can have a negative impact on returns, the breadth of responsible investing options provides plenty of wiggle room.
Twenty-one of the funds on the RIA’s list do not perform any negative screens. One of them, the Ferique European Equity Fund, only discloses its top 25 holdings and had BP, Royal Dutch Shell PLC, Portugal-based oil and gas company Galp Energia SGPS, S.A and British American Tobacco Plc within them.
“If you like everything in your portfolio, you’re probably not diversified,” said Jay Aizanman, a strategic advisor at Desjardins who helped put together the firm’s suite of ESG ETFs. “Yes, you could theoretically eliminate sectors, but that might not necessarily do something for your performance long-term.”
Most of Desjardins’ ESG ETFs are described in their titles as being “Low CO2” but only negatively screen for tobacco and weapons stocks. As a result, investors will find names like Enbridge, Coal India Ltd. and Pembina Pipeline Corp. in the funds.
According to the Desjardins prospectuses of these ETFs, “carbon filtering” is conducted by removing the “most carbon intensive stocks.” The firm is only seeking to reduce its carbon footprint by 25 per cent, Aizanman said, because a study it conducted revealed that returns would be impacted if Desjardins went any further.
In some cases, fund providers use strong, but vague language in their prospectuses against investing in certain sectors but don’t expressly screen for them, meaning that some of the stocks are allowed to enter portfolios on technicalities.
Desjardins’ fossil fuel reserves free ETF was represented on the RIA site as negatively screening for fossil fuels — but it only eliminates companies that have fossil fuel reserves. Because it doesn’t own fossil fuel reserves but only processes them, AltaGas Ltd., is included in the portfolio without breaching the prospectus’s guidelines.
Pembina remains a top holding in the CIBC Woody Gundy Blue Heron Income ESG Leader fund because the fund only screens for “integrated oil and oil, gas and coal exploration and/or production companies” and not those that transport fossil fuels, portfolio manager Graham Isenegger said.
Supermajor BP is still a part of the Russell Investments ESG Global Equity Pool despite a focus to tilt the “portfolio away from those companies with greatest exposure to carbon-related risk,” according to its prospectus.
Russell Investments spokesperson Steve Claiborne defended the investment, arguing the firm’s research shows “divesting entirely from fossil fuels can lead to lower exposures to renewable energy because many companies that hold fossil fuel reserves are also some of the largest investors in renewable technologies.”
Even the country’s largest pension plans have followed this strategy, championing commitments to responsible investing, which still allow them to actively purchase everything from oil and gas stocks to weapons manufacturers. Take the Canada Pension Plan Investment Board, as an example, which has US$685 million in Canadian Natural Resources Ltd. — it’s 10th largest holding, according to its most recent disclosures to the SEC — and has faced criticism as recently as September for owning assault rifle maker Ruger and Olin Corp.
The CPPIB’s policy on responsible investing, which was written in 2010, sets the fund up to pursue two responsible investing techniques: It uses ESG integration in its investment decision-making process and flexes its power as a shareholder to pressure companies into adapting stronger policy.
Its mandate, however, is to maximize returns for beneficiaries.
“Investment analysis should incorporate ESG factors,” the policy states, but only “to the extent that they affect risk and return.”
AGF’s AGFiQ Enhanced Global ESG Factor ETF appears to be a different case. Its prospectus doesn’t say that the fund screens against fossil fuels but does commit to removing companies with “severe ESG controversies.”
Nevertheless, Exxon Mobil, a company in court for allegedly lying about the impact on climate change to its business, was in its holdings.
When contacted, Mark Stacey, the head of AGFIQ Portfolio Management, wouldn’t specifically comment on Exxon’s inclusion.
“We are confident that the process we have in place will allow us to identify and mitigate the risks associated with ESG controversies in a timely and efficient manner,” Stacey said.
With no ESG-specific organization dedicated to ensuring firms stay on task with their funds, regulation falls to the Ontario Securities Commission.
“Staff regularly conducts reviews of investment funds on a risk-based approach and assesses how they are fulfilling their stated investments objectives and strategies,” said Raymond Chan, director of investment funds and structured products.
But the confusion around the sector remains.
Laura Nishikawa, head of ESG research at index provider MSCI, which has created more than 1,000 ESG indexes based on its rankings of 8,000 companies, doesn’t think the variety of responsible investing choices is problematic. The use of “umbrella terms” are what is.
“I think what’s a problem is the confusion around those choices and the use of these umbrella terms like ‘ESG’ or ‘sustainable’ that actually mean a lot of different things to a lot of different people,” she said. “So that’s an area where we’ve been working really hard to add that transparency.”
Its an idea that Nash, the financial planner, agrees with. Because a variety of funds are presented in a similar and arguably flawed way, investors may wrongly believe they’re ridding themselves of certain stocks.
Nash says he gets irritated each time he hears advertisements for Wealthsimple’s socially responsible portfolio, which gives clients exposure to Suncor Energy Inc., because he knows how much the provider’s idea of a responsible investing fund differs from his own.
“In that advertisement, they’re setting themselves to the high bar that I know I want to achieve with my personal portfolio but having looked at the holdings inside, I know they fall so short of where my ethical bar is,” Nash said.
Umbrella terms like ‘ESG’ or ‘sustainable’ … actually mean a lot of different things to a lot of different people
A Wealthsimple spokesperson said the online investment manager’s approach to responsible investing is to not eliminate sectors completely but to select the top companies in each one based on their ESG scores.
“We’ve approached it by building parameters around how we define socially responsible investing (through social, environment and governance factors), and how we believe the vast majority of people would want to see it represented,” the spokesperson said in an email.
Nash’s solution is to sit his clients down and open up portfolios of the funds to determine how strict his clients wish to be with their ESG integration.
The Post analysis found a number of options listed on the RIA’s marketplace that may appeal to a traditional responsible investor. Horizons’ Global Sustainability Leaders Index ETF, BMO’s Sustainable Global Opportunities Global Equity Fund and a host of Stewart Investors funds, based on their top holdings, appeared free of fossil fuels and sin stocks.
“Investors just can’t invest blindly. They need to ask questions. They need to look at the methodology of the fund they’re buying and they need to take that extra step of looking at the underlying holdings,” Nash said. “It is one of these things where the devil is in the details.”