Renaming trend may lead to a short uptick in greenwashing, but ultimately will accelerate the path to net zero and offer sustainable investors more choice.
Making up the majority of the green funds market in Europe, relabelled products are treated with caution and sometimes scepticism, but new analysis suggests their characteristics and performance bear comparison with funds designed to be sustainable from the outset.
The renaming of funds allows asset managers to leverage existing assets to build their ESG fund offerings and avoid creating funds from scratch. It also allows for a “fund to be withdrawn from a declining or less favoured segment and repositioned into a more dynamic one”, according to a recent Morningstar report on ‘Rebranded ESG Funds’.
Investor appetite for sustainable investment continues to increase, but demand is outstripping supply, with nearly nine in ten (88%) of institutional investors calling for more product innovation from asset managers. In response, asset managers have launched a plethora of new offerings but more frequently are rebranding existing funds to focus on ESG factors.
In fact, current growth in ESG investments is derived largely from retrofitted funds, a report by PwC noted. At the end of 2021, 27% of funds in Europe had been repurposed to integrate ESG factors.
Regulatory action has also fuelled the surge in ESG rebranding, starting with the introduction of the EU Action Plan on Sustainable Finance in 2018 and accelerating in 2021, due to the implementation of the EU Sustainable Finance Disclosure Regulation (SFDR). A further spike is expected when the UK Sustainability Disclosure Requirements (SDR) introduce new fund labels and disclosure requirements in June 2024.
“An unresolved moral and legal concern remains as to whether these rebranded funds falsely portray themselves as having ESG at the centre of their investing strategy in order to attract investor money, a practice characterised as greenwashing,” the Morningstar report noted.
Investor caution about rebranded funds is reflected in capital inflows and outflows in the period before and after rebranding activity takes place.
Rebranded funds posted net outflows on average in the 12-month period preceding the rebranding date and registered net inflows over the nine months following the rebranding date, with flows declining thereafter, according to the Morningstar report which is based on 975 rebranded funds between 1 January 2018 and 30 November 2022.
Investors often take a “wait and see” approach to rebranded funds, said Boya Wang, ESG Analyst at Morningstar, and author of the report. Once investors feel confident with the new strategic direction, they are often happy to reallocate their capital in the fund.
Asset managers that opt to rebrand ESG funds must remember that by doing so they face competition from non-rebranded sustainable funds, said Wang.
Sometimes fund outflows of rebranded ESG funds are related to investors choosing to invest in an existing, well-established sustainable fund with a proven track record over a rebranded one, he explained.
The decision to rebrand a fund often raises eyebrows, with investors “intuitively suspicious” of the activity due to greenwashing concerns among others.
Imperfect path forward
Rebranded funds reduce exposure to contentious activities such as controversial weapons, tobacco, and fossil fuel, ahead of changing names, the Morningstar report noted. Further, exposure to these activities remains largely unchanged rebranding and higher than that of non-rebranded sustainable counterparts.
“Overall, in terms of fossil fuel and thermal coal involvement, there is a reduction in exposure to these activities in rebranded ESG funds – that’s a positive sign,” said Wang.
Invesco Energy Transition Fund, an Article 9 fund previously known as Invesco Energy Fund, stands out for its largest in class fossil fuel exposure reduction (down 87%), in the report. With significant divestment from the traditional energy sector, the fund’s holdings are now mostly concentrated in utilities and industrials sectors that provide alternative energy solutions and services.
“However, when compared to new, non-rebranded sustainable counterparts, rebranded ESG funds still have a long way to go to catch up with them,” Wang said, adding that rebranded funds are somewhat constrained by their investment strategy and management capacity.
“Say for example a [rebranded fund] is divesting from a certain sector, but that sector has a transitional focus, then the fund cannot divest radically. In that case, you will see a reduction [in contentious activities] but there will still be a gap between rebranded ESG funds and non-rebranded ones.”
Wang admitted that the rebranding of funds over the short-term may lead to an increase in greenwashing, but overall rebranding activities will provide a net benefit by accelerating the path to net zero.
Investors must decide on how well-aligned funds are to climate action and sustainable outcomes, he said. “It’s always better for investors to have more choice.”
Increased investor demand for sustainable investment and increased regulation continues to drive asset managers to rebrand ESG funds, he said.
The UK’s SDR regime and planned Green Taxonomy provide a roadmap for fund managers to contribute to the “greening” of the financial system and support net zero commitments but “it’s far from perfect”, he said.
“If you want to rebrand your funds, or if you want to label your funds in general, [SDR] helps identify which bucket you place your fund in, but it’s still not completely clear,” said Wang.
Rebranding can also involve complicated asset reallocation and legal procedures performed in advance to account for fiduciary duties to investors.
“When you change your investment mandate and strategies, you have an obligation to communicate that to your investors, and some might not be happy with the new direction a firm is taking the repurposed fund,” he said. “This can lead to investors divesting their money from the fund.”