Stockholm (NordSIP) – Headline writers and social media attention-seekers had a field day this week, when they found out to their delight that a private equity firm called Ethical Capital Partners (ECP) had bought Mindgeek, the owners of Pornhub. The latter is the world’s 4th most visited website and has recently been the subject of various lawsuits alleging the hosting of illegal content. Given that pornography is often the first item on the exclusion lists of many institutional investors, its juxtaposition with the term “ethical” has raised a few eyebrows.
ECP makes the argument that part of its added value is in buying problematic businesses and helping them to improve as corporate citizens, which it say justifies the company name. A sort of social and governance-focused transition investing, perhaps? Just as some activist investors hope to steer the likes of ExxonMobil towards renewables, ECP presumably intends to make sure Pornhub’s content maintains some sort of acceptable minimum standards. Laundromat’s reaction to either of these aims would be: “Good luck with that!”
ESG fund industry’s out-of-control word cloud
Rather than spend time “researching” the standard of content of the world 4th most popular website, Laundromat would prefer to focus on the investment industry’s growing tendency to assign itself reassuringly sustainability and ethically flavoured names. On March 17th Novethic, the sustainability think-tank of France’s state-owned Caisse des Dépôts, published its analysis of the credentials of almost 1,000 funds marketed in Europe under ESG-related names (French language link). 357 of these funds were labelled as Socially Responsible Investment (SRI), Environmental, Social and Governance (ESG) or ethical and 272 included references to the UN Sustainable Development Goals (SDGs), transition investing or engagement. The remainder operated under thematic labels such as climate change, net-zero, low carbon, impact, green, water, or nature.
Novethic presents the results of its analysis against the backdrop of industry trends and regulatory developments. It believes that strong positive net inflows over the last two years for SFDR Article 6 and 8 funds have been driven by an incorrect assumption on investors’ part that this classification denotes implicit quality and sustainability credentials. While these inflows are now picking up after dropping off quite sharply in reaction to the Ukraine war, demand for Article 9 funds has been consistently growing throughout the period. Novethic also finds that over the past 12 months 47% of Article 9 funds marketed in France have been reclassified to Article 8. The power of fund naming is evident in a demonstrable demand boost enjoyed by Article 9 funds with an explicit sustainability-related name versus those with a more neutral title.
Stick an ESG label on it and it will sell
This name-related marketing boost leads Novethic to take a closer look at those funds that have recently changed their name, perhaps by adding terms like “sustainable” or “ESG” or moving from a neutral “active equity” to something like “social leaders.” While its analysis shows some cases where the name change reflected a genuine change in strategy, it also reveals large numbers of funds guilty of greenwashing by simply repackaging existing products.
Unfortunately, most end investors are not in a position to carry out the such forensic analysis before investing their hard-earned money. Novethic maps out the current regulatory environment affecting the fund market in France, with various sustainability labelling, SFDR classification and European ESG Template (EET) frameworks underscored by methodologies which the report flags as accessible to end investors or simply “unreadable.”
To illustrate the problem, Novethic selects four funds all sharing the same name: Climate Action. The minimum allocation to sustainable assets ranged from 10% to 90%. One fund is committed to 100% of these sustainable assets (as defined by SFDR) having an environmental focus, whereas others have a minimum of only 25%, which would seem very low for a so-called climate strategy. The stark conclusion is that despite sharing a name, these funds have very little in common.
Proper policing is long overdue
Novethic is calling for the European Supervisory Authorities to speed up their efforts to liberate the fund markets from what it calls its state of total confusion. Interestingly, Novethic points to the UK’s post-Brexit SDR (equivalent of the SFDR) as having clearer structure, with its “sustainable focus”, “sustainable improvers” and “sustainable impact” categories having a fairly solid methodology behind them. Novethic would like to see the end of fund managers having the liberty to set their own definitions of sustainability, and calls for regulators to deliver a final and workable definition of the transition. In the meantime, we will have to navigate carefully through the smoke and mirrors, and check extremely carefully exactly what we are getting into when investing in an “ethical” fund.
