Do Institutional Investors Over-Report Their Greenness?

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    Stockholm (NordSIP) – Although some estimates put ESG investing at $35 trillion, there seems to be mounting evidence that the talk about institutional investors’ commitment to green investments is much louder than the extent of their walk down this path might suggest. Now, a new study by Wharton finance professors Luke Taylor and Robert F. Stambaugh and finance professor Lubos Pastor of the University of Chicago adds fuel to this controversy.

    The paper, titled “Green Tilts”, which won a 2023 Outstanding Paper award from Wharton’s Jacobs Levy Equity Management Center, argues that there is large gap between actual ESG investments and those that are reported. “That US$35 trillion number overstates the amount of ESG investing; there is much less ESG investing than is popularly reported,” Taylor says.

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    According to the study argues that the investment industry’s ESG-related tilt has been fairly steady at 6% throughout its sample period from 2012 to 2021. This is true as of 2021, where the ESG-related tilt in the portfolios of large institutional investors only represent 6% of the US$31.3 trillion in assets they managed, or approximately US$2 trillion.

    How to Greenwash

    Taylor, Stambaugh and Pastor argue that the common approach to measuring ESG investing of adding up the assets under management of institutions that include ESG in their stated investment policies misses some details.

    The authors argue that “an institution may tilt its portfolio toward assets with favorable ESG characteristics, i.e., green assets, and away from unfavourable brown assets, but those tilts might be very modest, typifying a practice known as greenwashing. (…) A fund — let’s say a mutual fund — might label itself an ESG fund, but engage in greenwashing, only tilting its portfolio a little bit toward green stocks,” Taylor said. “It’s just false advertising by the fund. Putting 100% of that mutual fund’s assets in the ESG bucket is surely too much.”

    A “New” Approach to Measuring Greenness

    To estimate the scale of institutional ESG investments, the study considers the ESG-related portions of institutions’ portfolio weights, a seemingly novel approach. It also narrows its universe of institutional investors to the equity portfolios of so-called 13F institutions, defined by the Securities and Exchange Commission (SEC) as those that hold at least $100 million in U.S. stocks.

    For each institution, the authors estimated how every stock’s ESG characteristics relate to the stock’s weight in the institution’s portfolio to determine its ESG-related tilt. It then aggregated those tilts across institutions to estimate the total ESG-related portfolio tilt in the investment industry.

    The study was also able to take advantage of MSCI ESG ratings in order to distinguish between environmental, social and governance characteristics, noting that  using only a composite ESG score misses over 40% of the tilts associated with E, S, and G characteristics. “For example, an institution may hold Tesla’s stock because it views Tesla as environmentally friendly or because it likes holding large-cap growth stocks. Our approach separates the two motives. Second, our approach allows the three dimensions of ESG to enter separately, recognizing, for example, that investors may assess Tesla’s environmental virtues separately from Tesla’s treatment of its employees.”

    With so many investors touting their so-called sustainability, their clients would benefit greatly from increased transparency. “It would be nice to see funds report their ESG-related tilt; the E, S, and G components; and the degree to which those tilts are in a green versus brown direction,” Taylor argues.

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