Why so-called "responsible" investment funds are not necessarily more virtuous than others
In an article originally published in French on The Conversation, Mirco Rubin (EDHEC), Ioana-Stefania Popescu and Thomas Gibon (LIST) present their work on the effect of including life cycle analysis in ESG ratings.
The market for sustainable investment products is expected to account for a third of the total market by 2025, or around $53,000 billion. However, there is no clear, agreed standard for measuring the sustainability of investment products.
Asset managers, who invest money on behalf of end investors such as pension funds, insurance companies or private investors, use different strategies to integrate sustainability, with a degree of requirement that is difficult to judge. For example, the use of environmental, social and governance (ESG) criteria as an indicator of sustainability has been heavily criticised, and many so-called "responsible" or "green" funds may in fact be conventional funds in disguise.
So how can the end investor be sure that an investment portfolio is genuinely green and not just an attempt at greenwashing? What do we mean by "green"?
A harsh assessment of SRI funds
Providing answers to these questions and going beyond ESG ratings as sustainability indicators requires the use of methods such as life cycle analysis (LCA). LCA involves quantitatively estimating the carbon footprint (among other things) associated with investment funds, via the shares in the companies that make up these funds.
The greenhouse gas (GHG) emission factors used include direct emissions (Scope 1) and indirect emissions (Scopes 2 and 3), which are themselves linked to the economic sectors and countries in which each company operates. The data is derived from input-output tables with environmental satellite accounts (EE-MRIO), which are based on national statistics on atmospheric emissions broken down by sector of activity.
It should be noted that this method does not allow the precise quantification of a company's impact, but it does allow a standardised estimate to be made of the full life-cycle impacts associated with a company's activities. As funds sometimes invest in hundreds of companies belonging to different sectors or countries, only a global methodology for estimating the impact on all companies allows easy aggregation at fund level.
Using this new approach, we found in a recent study that socially responsible investment (SRI) funds are not systematically less carbon-intensive than their conventional counterparts: 23% of a sample of 670 SRI funds domiciled in Europe have a direct carbon footprint (linked to activities on company sites) greater than that of the conventional MSCI World market index, chosen as a benchmark.
When we then analyse the indirect carbon footprint, associated with the value chain of the companies in which they invest, we find that 67% of SRI funds scored lower than the MSCI World index, showing that covering all upstream activities is essential for an accurate representation of impacts.
In the sample of funds analysed, supply chain emissions represent more than half of the total impact; this makes them an essential element of emissions measurement, helping to understand in which industries a fund should invest less (or more) to achieve the greatest reduction in GHG emissions.
For example, a company may have the highest environmental performance ranking in its sector, with its head office using 100% clean energy, but be heavily reliant on fossil fuel power generation in China for outsourced manufacturing of its products.
The key role of regulation?
Stricter classifications imposed by regulators should help investors to distinguish between genuinely responsible funds and funds that simply use sustainability as a marketing tool. However, on the market, only a very small percentage of sustainable funds can be identified as impact funds and active funds - funds that have a specific sustainability objective and are actively investing towards it.
Most SRI funds, however, are content to follow market indices or select best-in-class companies across all sectors, even if this includes fossil fuel companies, and shift portfolios towards sectors that are already decarbonising, such as technology or healthcare, while retaining polluting companies.
Without being truly responsible or green funds, these funds can also achieve better carbon footprint results than, for example, a fund investing in the manufacture of materials for low-carbon electricity generation, simply because of the energy-intensive activities to which the latter is exposed. This is why the assessment of the total (absolute) carbon footprint needs to be complemented by an assessment of progress (relative) towards decarbonisation targets, so that impact funds are not penalised.
Finally, while our estimation tool can improve understanding and calculation of impact, there may be differences at the sub-sector level that are not measurable with our model - for example, the database used does not distinguish between the manufacture of electric vehicles and combustion engine vehicles. In the future, a finer level of detail in the environmental databases used to estimate carbon footprints, as well as the provision of physical data (and not just monetary data) from companies, will enable the LCA method to be applied more robustly, guaranteeing better estimates of environmental impacts at the scale of a fund.
It should be noted, however, that full measurement of GHG emissions, including the impacts of the upstream value chain, is only one piece of the puzzle in measuring the contribution to decarbonisation, and will not bring about change on its own. It's time to move from assessment to action: investment funds should estimate their full responsibility for the effects of climate change and prioritise action, engaging with investee companies to drive real change and assess progress towards those companies' targets.
This article by Mirco Rubin, EDHEC Associate Professor, Ioana-Stefania Popescu, PhD Student in Sustainable Finance, Luxembourg Institute of Science and Technology (LIST) and Thomas Gibon, Research Associate, Luxembourg Institute of Science and Technology (LIST) has been republished from The Conversation (french version) under Creative Commons licence. Lire l’article original.
Photo by Greg Rosenke on Unsplash
