Are your investments causing harm?

New reports suggest it isn't just the big, bad hedge fund guys on Wall Street destroying the planet. The average individual who has a 401(k) retirement account, a pension, or even an investment portfolio concentrated in “Environmental, Social, Governance” (ESG) funds is also contributing to pollution and the climate crisis. Last month, Bloomberg reported that 100 million people in the U.S. “have no idea that they’re investing in their own destruction.”

This comes as unwelcome news for many, as it signals the end of the attractive notion that it’s easy to save the planet and make money at the same time. According to a report by the Forum for Sustainable and Responsible Investment, U.S. assets invested in so-called ESG funds totaled $17.1 trillion at the beginning of 2020. That is, investors have poured their resources into “green” strategies with unbridled — and perhaps blind — optimism.

Investing with a conscience is not as easy as many believed.

“We've heard people think that ESG stands for ‘Environmental and Social Good,’” said Zach Stein, co-founder and CEO of Carbon Collective, an online investment firm that helps clients divest from fossil fuels. “I think that generally speaks to what most individual investors imagine they'll see when they crack open an ESG fund — companies that clearly are doing some kind of good in the world.”

Unfortunately, that perception is inaccurate: ESG funds have been exposed as misleading, or even an outright sham.

For investors who hope to do better for the planet, the bad news seems clear: Investing with a conscience is not as easy as many believed. Yet there appears to be good news too. Some investments can genuinely meet the twin goals of bettering the planet while delivering a return.

But they’re harder to find. 

The three largest ESG funds held a total of around $46 billion in assets as of April 2021 — and a quick peek into the details of what these funds contain reveals a sinister scenario. (If you want to check your own account statements to see if you’re invested in these funds, they’re called the Parnassus Core Equity Fund, iShares ESG Aware MSCI USA ETF, and the Vanguard FTSE Social Index Fund.)

The iShares ESG fund has holdings in Exxon and Chevron. Chevron, meanwhile, has been repeatedly accused of greenwashing, with the Federal Trade Commission receiving complaints from several environmental organizations contending that the oil giant has misrepresented its efforts to help the planet.

Wall Street is committed to generating predictable returns, which leads banks to package ESG funds to be less bad than the average fund — but less bad doesn’t necessarily equal good for the planet.

Parnassus’ ESG fund is invested in the paint manufacturer Sherwin Williams, which has been sued on multiple occasions for polluting communities and harming air quality.

Vanguard’s ESG is invested in Mondelez, a food company that said it had reduced its carbon footprint — which it accomplished by shifting responsibility to its suppliers, who have not, in turn, reduced their carbon footprint.

These three major ESGs reveal that there is a disconnect between Wall Street’s approach to packaging ESG funds, and the hopes of individual investors who are buying them. Wall Street is committed to generating predictable returns, which leads banks to package ESG funds to be less bad than the average fund — but less bad doesn’t necessarily equal good for the planet.

Part of the problem also stems from the very concept of “ESG.” The framework of “Environmental, Social, Governance” was initially designed to be a big tent that could encompass a wide range of goals, from environmental stewardship to human rights and labor standards. But the vagueness of the term created room for large institutions to include stocks that aren’t “environmental” at all, even if they’re marketed as such.

One famous ESG — the S&P’s ESG 500 index — did not include Tesla but included Exxon. Why? Because Exxon, despite its poor environmental rating, had high ratings in “social” and “governance.” So its stock was deemed “ESG.”

“Even though environmental is often the most pressing issue for investors, ESG ratings systems rate E, S, and G equally, meaning a company can be terrible in one — such as pollution — but still make it in,” said Stein.

It might be time to look beyond the major stocks.

This also points to a deeper problem. Companies use raw materials to create products that many of us ordinary consumers enjoy every day. In virtually all successful business models in today’s global economy, the process of creating products brings with it a carbon footprint and, in many cases, involves the use of harmful chemicals or the production of disposable packaging that can end up in the ocean. Both the iShares and Vanguard ESG funds mentioned above are invested in beverage companies that are the world’s top plastic polluters, while tech companies produce staggering volumes of e-waste and have outsized carbon footprints.

In other words, when you really get into the details, the possibilities of including major stocks in a genuinely green fund vanish quickly. That’s why it might be time to look beyond the major stocks. In the words of a favored tech company whose stock, rightly or wrongly, is touted as “ESG,” it might be time to “think different.”

Regenerate

According to Project Drawdown, about $632 billion was dedicated to global climate finance annually in 2019 and 2020. But that amount is not sufficient to limit global warming to 2 degrees Celsius above pre-industrial levels. (If temperatures rise by more than 2 degrees Celsius, 1 billion people could face lethal danger from heat stress.) To meet international climate goals and prevent further catastrophic effects, an increase of at least 590% in annual climate finance — to $4.35 trillion annually — is needed by 2030.

Researchers at Imperial College London’s business school compared the returns from the largest fossil fuel and renewable energy stocks over the last 10 years. They found that renewable energy stocks delivered higher returns for both five and 10-year time periods as compared to the fossil fuel companies.

Can ordinary investors put their money toward climate finance and earn the return they want or need for their retirement and financial security? Some initial data suggests the answer might be yes.

Researchers at Imperial College London’s business school compared the returns from the largest fossil fuel and renewable energy stocks over the last 10 years. They found that renewable energy stocks delivered higher returns for both five and 10-year time periods as compared to the fossil fuel companies.

Those numbers are promising, but we don’t want to oversimplify. While all investments carry inherent risk, choosing individual stocks requires a level of financial expertise most people do not have. That’s why many investors — including many institutional investors, such as state pensions — often choose to invest in funds. Funds bundle a large group of stocks together. This bundling creates diversification, and a diversified portfolio reduces risk and increases the odds of a solid financial return.

In other words, while it is theoretically possible to invest directly in climate finance and earn a better return than you’d get from investing in the major polluters, it’s easier said than done.

Yet that’s just one alternative approach. There are also possibilities for genuinely green investing that move beyond Western-centric finance, toward different models designed to undo damage and foster environmental regeneration.