Are Sustainable Investment Funds a Scam?

Millennials, don’t feel duped. The financial sector is trying. Really trying, okay? Change doesn't happen overnight, and the same is true for sustainable investing. 

You might be asking yourself why nearly every robo advisor and wealth management firm now touts sustainable investment funds like a new fleet of Teslas on a car lot. If you’re worried that sustainable investments aren't all they're marketed to be, you're not alone. Ask your friends and neighbors how many corporations in the S&P 500 publicize their annual plastic consumption, or how exactly companies they patronize plan to follow through on river clean ups—and probably nobody would know.

That’s the conundrum of sustainable investing. You want to invest for a better world, but how can you know if what you're investing in is really green?

Let's dive into the real benefits sustainable investing brings—and some of its limitations.

Sustainable investment funds are often called “SRI” funds or “ESG” funds. SRI stands for “socially responsible investing.” Meanwhile, the acronym “ESG” stands for environmental, social and governance.

These sustainable investment funds pool investor money and invest it across a diversified "basket" of securities, with a focus on investing in companies and within sectors that follow sustainable practices. Institutional investors, retail investors, and even stock exchanges use ESG indicators to evaluate and rate corporations on how good they are doing in the march towards a sustainable and equitable future.

While there’s no one “true” rating system, companies across the financial sector have come up with hundreds of ESG indicators. They could include:

• Environmental criteria (greenhouse gas emissions; rate of renewable energy usage; pollution; animal welfare)
• Social criteria (diversity, equity, and inclusion efforts; donations to human rights organizations)
• Governance criteria (shareholder transparency; corporate accountability; appropriate data and metrics)

Passive investment funds such as index funds, ETFs, and mutual funds appeal to ordinary investors because they spread risk out by investing in small numbers of shares in many different companies at once. 

The S&P 500, for instance—one of the most popular traditional index funds—contains 500 of the biggest, most diversified global companies across every major industry. Instead of investing in 500 individual shares to manage your risk, anybody can invest in shares of the S&P 500, which may contain fractional shares of every company in the index, and accomplish essentially the same thing.

“Green,” SRI, and/or ESG funds offer the same convenience and low-risk, no-fuss approach. Today, advisors and investment management institutions offer a growing number of ESG products. You can think of these products as specially curated mutual funds, index funds, and ETFs. They contain companies chosen for how well they rank according to any particular set of ESG factors. 

But every financial institution has its own list of factors, and nobody is really measuring the outcomes—which is part of the reason why ESG investing raises some eyebrows.

In theory, ESG funds are a win-win. Investors can still enjoy a profit while making the planet better—hooray!

But ESG funds have their critics, and for good reason. Even former BlackRock chief information officer Tariq Fancy admitted earlier this year to having turned from ESG evangelist to sustainable investing whistleblower. 

“All they are talking about is protecting investment portfolios from the carnage [of climate change],” Fancy said of the institutional investors who promote their ESG funds proudly.

By this he means that choosing ESG or SRI funds might make people feel like we’re stopping climate change, but it hasn't been shown that our dollars are making a measurable impact on climate change. He claims that in reality, ESG funds are most often created to mitigate any potential financial consequences that public companies could face from climate-related impact and negative public perception. In other words, ESG funds might be more about harm reduction for the corporations involved than promoting actual solutions. Here are some reasons why.

Divestment doesn't have a demonstrated impact

The rallying call for divestment is powerful. Cutting fossil fuel companies from your portfolio might feel as liberating as deleting your ex’s phone number, but as long as those industries are profitable, investors will always buy up the shares.  

In addition, companies, like individuals, don’t just keep their cash under a mattress. There’s nothing stopping companies with great ESG ratings from having portfolios of their own with a big stake in extractive and problematic industries.

Greenwashing is a huge problem in ESG investing

“Greenwashing,” or using marketing tactics to appear "green" without making any real changes has become one of the more common ESG trends as the demand for companies to follow more sustainable practices increases. Increasingly, nonprofits and even the SEC are gearing up to investigate the claims made by financial companies and ESG funds about their products’ sustainability, but we have a ways to go.

Part of the problem is that under the nascent and still-evolving ESG rating system, companies can fiddle with the optics of their business practices just to score a higher rating—without actually helping much. For instance, they might increase their diversity with a few new hires or tweak governance practices to improve their score while still dumping tons of chemicals into oceans and maintaining an all-white C-suite leadership.

They create a placebo effect that prevents investors from taking real action

Do you remember when you bought your first tube of Tom’s toothpaste? How good it felt? Sure, Tom’s may be a great company that sources its ingredients ethically, but did it change the way you personally treated people that week? When you order takeout from a restaurant that uses biodegradable flatware, do you also cut down on your plastic consumption in other areas of your life?

Your stock market choices work the same. It feels great to put your money towards companies that pledge to do better, but it also can diffuse the responsibility and make it easier for individuals to ignore opportunities to personally contribute.

All this said, ESG funds are kind of the best we’ve got—at least when it comes to investing in index funds, mutual funds, and ETFs. There are innumerable ways to make sustainable and ethical choices in your own personal life, but the fact remains that corporate activity leaves the largest carbon footprint on the planet and uses the most resources by far. We therefore can’t really drop out and ignore what happens in the stock market.

The main benefits of ESG funds are:

• They ask companies to look closer at their practices, from biodiversity to racial justice.
• They contribute to incremental change that, with time and great effort, moves the needle forward on issues.
• They create more transparency between financial advisories and consumers as the financial sector responds to the demand of its customers.
• They encourage shareholder engagement and require the average person to think critically about where their money is going and educate themselves.
• They can motivate investors to make sure their portfolio aligns with their values, as opposed to passively putting money into a 401(k) without checking which companies/sectors are included in it.

While the above benefits are a nice start, real progress can only come with continued follow-through and engagement. These trends could pose promising ways to drive change:

Shareholder advocacy

The high-profile ousting of three ExxonMobil board members last June showed the world that investors have some power to drive board decision making. The new impact investment firm, Engine No. 1, bought enough shares of Exxon to influence voting, and suggested four new hires to replace problematic board members. Three of the four were hired—huzzah. This approach requires a ton of patience, however, as it involves negotiating with corporate boards to get them to change their long-held way of doing business. It also requires a lot of capital.

Bringing clean tech to market

A major obstacle in changing the status quo is getting startups the funding they need to break through the status-quo. When venture capitalists and hedge funds invest in startups creating new clean and green technology, they directly enable progress—compared to simply mitigating damage the way passive ESG funds do. The platform Propel(x) was created to give more people access to investing in world-changing science and technology startups. It lets investors hold equity in STEM startups with a minimum buy-in of $5,000.

The options above are often only accessible to accredited investors, institutional investors, private equity firms, etc. For everyday retail investors (the little guys), similar options exist on a different scale.

Crowdfunding

Thanks to the fintech world, a good number of investment platforms that use crowdfunding to let investors invest in small businesses and startups now exist. Keeping in mind the higher risk, you can use these platforms to support businesses practicing and promoting sustainability.

The platform MicroVentures has a minimum investment of just $100, and with over 400 startups on the platform, you’d have your pick.

Buying individual stocks in sustainable companies

Buying individual stocks comes with higher risk than passive investing and requires a lot more research. But for someone in a good financial position with some investing savvy, this way would directly enable solutions-oriented companies. 

If you want to support renewable energy, plant-based meat alternatives, or electric cars, keep a close watch on the news and look for appealing companies putting these ethics into practice. It doesn’t take long for an obscure company to take the world by storm and change the way we live, as we saw when the alternative milk brand Oatly’s went public at $17 per share in May 2021.

Though Oatly’s share price is now lower, it is valued at $10 billion. Its investors include the likes of Oprah, and it's offered at Starbucks. The brand has come a long way since its founding in 1994 and has helped normalize the use of dairy-free milk.

Carbon neutral crypto and NFTs

Bitcoin has been called a disaster for the environment due to the amount of energy it takes to mine. But since its birth, newer currencies and blockchain platforms and currencies have emerged. For example, Palm (built with Ethereum) is an NFT ecosystem that proclaims to be 99% more energy efficient than most blockchain networks. Again, look out for greenwashing here, and keep up with oversight efforts from groups like the Crypto Climate Accord.