ESG investing focuses on incorporating environmental, social, and governance principles into a fund’s investment strategy. These portfolios often consist of investments in assets that promote green energy, climate preservation, Diversity, Equity, and Inclusion initiatives, and equal access to opportunities.
Interest in ESG investment strategies has increased in recent years, as investors are attracted to not only the ethical benefits that ESG investments offer, but also the idea that strong ESG principles can help firms improve long-term performance and reduce risk.
As ESG investing increases in popularity, one concern is that different funds have varying criteria for their ESG strategies. For example, less intensive strategies may prohibit investments in securities that directly conflict with ESG principles, such as alcohol, tobacco, firearms, and gambling, but still not focus their investments on assets that actively align with ESG principles. Other funds may actively invest in companies with strong ESG initiatives but profit from loans issued to companies with poor ESG practices. Funds with the most intensive ESG strategies actively invest the majority of their assets in securities that promote ESG solutions.
When constructing and managing ESG portfolios, it is important for investment managers to define what qualifies as an “ESG investment” and disclose these criteria to investors. This can help firms avoid greenwashing, which occurs when firms overstate the extent to which their portfolios are aligned with ESG practices. Greenwashing misleads investors and can prompt SEC investigations and penalties.
Currently, the SEC is working to combat greenwashing by cracking down on transparency and disclosures regarding ESG practices. For example, the “Names Rule” requires that institutions choose fund names that accurately represent the positions held in the portfolio. This means that funds using terms such as “ESG” or “sustainability” in their names must invest at least 80% of their assets in securities that align with these terms. While the SEC has not yet set criteria for what qualifies as an ESG investment, firms are required to define and disclose their ESG criteria to investors.
In 2024, the SEC also passed the "Enhancement and Standardization of Climate-Related Disclosures for Investors" which will require public companies to disclose their climate-related practices in their annual reports beginning in 2025.
Recently, the SEC investigated Invesco and issued a $17.5 million fine, finding that the firm had misled investors about the ESG practices of their mutual funds and exchange traded funds. This is an example of greenwashing, as these funds were marketed to investors as ESG funds, but allegedly held large stakes in companies that did meet the ESG standards that Invesco had marketed to investors.
This case serves as a reminder for firms to review their ESG funds and ensure that all practices are aligned with disclosures and marketing materials. IMP is here to help firms evaluate their ESG fund requirements and implement solutions to ensure full compliance with SEC regulations and client guidelines.