Windfarm on Redcar coastline at sunset
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Regulators are cracking down on greenwashing in environmental, social and governance funds (The Big Read, June 7). However, even without greenwashing, investors are misled by ESG fund promoters.

A typical advertisement for ESG funds will read like this: “Investors in the fund will (1) reduce global warming and (2) do this without giving up returns.”

The first part of this statement is an obvious lie. The typical ESG fund gives no money to the companies in their portfolio. The funds exploit the apparent ignorance of many investors who believe that if they invest in, for example, the “Wind Energy Fund” they actually give money to the firms in the fund to produce wind energy. Nothing is further from the truth. The money invested in the fund is used to buy shares from other investors who sell their wind energy shares.

Some funds try to counter this by saying they “engage” with the company and send emails to the chief executive. But what’s the point of engaging if the company is already a high ESG-rated firm?

The worst offenders are funds that exclude so-called “brown” stocks and claim to make the world a better place. If you eliminate an oil and gas company from your portfolio someone else will buy it, so the world’s carbon footprint is not affected.

Some would argue that there could be a beneficial effect via the cost of capital: if ESG funds become the dominant investors in green stocks the cost of capital of green companies will fall, which will lead to more investment. But as a lower cost of capital translates into a lower expected return on equity it means the claim that investors in ESG funds won’t give up returns is false as well.

Regulators should protect investors by forcing funds to inform investors that they have no impact on the climate and are likely to get a lower rate of return.

Theo Vermaelen
Professor of Finance, Insead
Fontainebleau, France

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