By Thomas Kostigen
Let’s say you ordered a veggie pizza for delivery and when you get it and open the box, you find that the pie has pepperoni on it along with vegetables. And now let’s also say that you specifically ordered the veggie style because you wanted to avoid eating meat. Some investors are getting the same treatment with the types of funds they choose — discovering that they hold shares of companies in sectors they were specifically trying to avoid. It’s left a seriously bad taste in people’s mouths, so much so that the Securities and Exchange Commission (SEC) has stepped up efforts to do something about it by opening a public comment period to hear complaints.
The style of fund people are largely taking issue with is ESG, which stands for environmental, social, and governance. These funds are supposed to be investing in companies that have positive environmental, social issue, or corporate governance track records or missions in place. Think of a company such as Tesla for its environmental mission. Or Google for its social responsibility. (It’s motto, after all, is ‘Don’t be evil.”) Or HubSpot for its corporate governance (In just one example of many governance initiatives, the company holds a weekly video-conference “town hall” for all employees that provides a business update and a forum to celebrate success and for employees to ask questions.)
Nearly 90 percent of S&P 500 companies issue sustainability reports. That should give fund managers a pretty good sample of what companies are operating in a sustainable fashion. Sustainability is a descriptive that often replaced ESG in the finance world. However, it seems fund managers aren’t living up to their marketing labels.
According to a March 2, 2020 release, the SEC “is seeking public comment on the framework for addressing names of registered investment companies and business development companies that are likely to mislead investors about a fund’s investments and risks.”
The SEC has had since 2001 its Names Rule, requiring that a fund invest 80 percent of its assets in accordance with the style advertised. But it admits that the Names Rule is out of date. “Some funds appear to treat terms such as ‘ESG’ as an investment strategy (to which the Names Rule does not apply) and accordingly do not impose an 80 percent investment policy, while others appear to treat ‘ESG’ as a type of investment (which is subject to the Names Rule). In an increasingly competitive market environment, asset managers may have an incentive to use fund names as a way of differentiating new funds. This incentive may drive managers to select fund names that are more likely to attract assets (such as names suggesting various emerging technologies), but may not be consistent with the purpose of the Names Rule.”
In other words, because ESG funds are attracting assets —globally, ESG assets under management have grown 69 percent over the past two years alone to $17.5 trillion, with the United States leading the charge—managers may just use the ESG label without much regard for the underlying investments. This happened with Vanguard’s ESG US stock exchange traded fund; it was caught holding oil and gas stocks.
With its request for public comment, the SEC is seeking input on the challenges that the Names Rule may present, particularly in light of market changes since 2001, as well as potential alternatives to the current framework for prohibiting the use of deceptive and misleading fund names.
Financial advisors, of course, can vet ESG fund holdings on the behalf of investors. Individual investors may want to look under the hoods of their ESG funds and find out which companies they own.
Thomas Kostigen is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Thomas is a best-selling author and longtime journalist who writes about environmental, social, and governance issues.
