Retail investors are drawn to investment funds with strong ESG ratings — particularly ratings expressed with stars — and appear susceptible to greenwashing, according to an experiment carried out by a team at the Ontario Securities Commission (OSC).
In a new report, the regulator detailed an experiment with 961 retail investors to examine how different attributes would influence their decision to choose one hypothetical investment fund over another. The attributes tested in the experiment include fund names, investment strategies, ESG ratings, past performance and MERs.
“The ESG rating stood out as one of the most important attributes influencing consumer choice — second only to a fund’s past performance,” the researchers found
Both the format of these ratings — stars and letter grades — had an impact on investors.
“Star-rated funds had more positive influence on fund selection than letter-rated funds,” they found.
“Higher ESG ratings had more positive influence on fund selection than lower ESG ratings,” the report noted.
“The absence of an ESG rating was preferred to some of the lower ESG ratings, suggesting that there is a threshold at which ESG ratings transition from a motivating factor to a deterrent,” they said.
Additionally, the research found that investors were,”not sensitive to mismatches between a fund’s more salient attributes (e.g., fund name) and its actual investment strategy.” In other words, if a fund was labeled as an ESG fund, but didn’t have an actual ESG strategy, investors weren’t necessarily turned off by that discrepancy.
“This result suggests that Canadian retail investors may face risk from greenwashing of products available in the market,” the report said. “It is unlikely that retail investors fully understand ESG ratings, yet these ratings are a particularly important factor when selecting ESG investment funds.”
Additionally, the lack of standardization and clarity in these ratings potentially exacerbates the greenwashing risk, the report suggested.
“The different types of ratings and lack of clarity around ratings allow manufacturers of these funds to potentially exploit investors’ tendency to rely on ESG ratings,” it said.
“The OSC is concerned about this lack of transparency,” said Leslie Byberg, executive vice president, strategic regulation at the OSC, in a release.
“Clarity around ESG ratings will help investors make more informed decisions,” she added.
To that end, the report called for action from both the industry and regulators to improve the clarity of ESG definitions and ratings, alongside efforts to help both investors and advisors guard against greenwashing by boosting their understanding of ESG investing.