More and more businesses are opting for greenwashing rather than a genuine shift towards more ethical ways of doing business, but there are still plenty of ways for investors to spot the difference.

Speaking to nestegg, Emilie O’Neill, an ESG and equities investment analyst at Perennial Better Future, acknowledged that the lack of a standard approach to ESG management can make the space difficult to navigate, especially for first-time investors.

“In recent years, there has been a large increase in the number of ESG-related investment products on the market, fuelled by increasing demand from consumers who are more aware of where they are investing their money,” she said.

Referencing a report by the Responsible Investment Association of Australia, she claimed that 60 per cent of Australia’s investment management market is now playing in the ‘responsible’ investment space to varying degrees.

However, Ms O’Neill noted that “with the rise in popularity of ESG investing, some fund managers have sought to capture the increased flows by describing funds as an ESG or sustainable product without wanting to stray too far from the stocks in their more traditional fund”.

How do they handle negative screening?

When it comes to screening a potential ESG investment, Ms O’Neill advised investors to take a closer look at the fund’s own screening methods.

“Does the fund use negative screens and, if so, are the revenue thresholds that are used authentic? An exclusionary screen or negative screen is when a fund will exclude a company from its investment universe based on its exposure to a sector or industry which has ESG-related risks,” she said.

However, Ms O’Neill noted that the level of tolerance for ESG-related risks can vary from fund to fund or industry to industry.

She recommends that investors take a closer look and “beware of products which exclude controversial sectors yet have high percentage revenue tolerances”.

How do they approach positive screening?

Ms O’Neill also advocated for investors to be discerning when it comes to understanding how or whether a potential investment approaches positive screening. How a fund determines which investments to pursue matters as much as those it decides to avoid.

“As the name suggests, a positive screen seeks companies from an investable universe which have desirable ESG qualities,” she said.

There are two kinds of positive screening methods that are used by funds to gauge the validity of a company’s ESG status, Ms O’Neill explained.

Under a revenue threshold system, ethical funds will only invest in companies that derive a certain percentage of its revenue from a sector which has desirable ESG qualities, such as water, waste management or social outcomes.

Score-based systems, on the other hand, see companies assigned an aggregate score through an internal or third party based on its performance when it comes to ESG values. Funds then decide to invest or not invest based on that score.

How transparent are they?

Transparency is one of the biggest flash points in the debate around ethical investing, and Ms O’Neill reiterated the importance of asking whether a fund publishes a full list of their investments to investors.

According to her, “Best practice is to publish a full list of holdings, typically on a lagged basis rather than just publishing the top five or 10 holdings. This allows investors to consider whether the companies in the portfolio align with their views on sustainability.”

Unfortunately, not all ethical investment funds rise to this challenge.

Recent research done by the Responsible Investment Association Australasia found that of the 165 ethical investment managers surveyed, just 27 per cent applied a leading approach to responsible investment. Thirty-six per cent disclosed their full fund holdings, while the remaining 28 per cent only disclosed some holdings.

Have they experienced any ESG controversies in the past?

Although she acknowledges that an investment fund having experienced an ESG-related controversy is often a red flag, Ms O’Neill argued that this shouldn’t necessarily be a dealbreaker.

She noted that “often, companies that are involved in controversies seek to learn from their mistakes and greatly improve their ESG practices”.

“However, some don’t learn, and these are the companies where the business is likely to be negatively impacted in the medium term.”

Do they publish their proxy voting record?

In addition to their investments, Ms O’Neill calls out a fund’s proxy voting record as another key thing for ethical investors to pay closer attention towards.

“This allows investors to look through the record and consider whether a fund has actively used voting rights to improve outcomes where an annual general meeting of the company is considering a controversial issue,” she said.

Do they integrate their ESG team properly?

If you want to gauge how serious a fund is about ESG performance, look no further than its org chart.

These days, it’s not just enough to have a dedicated sustainability committee or team. Those human resources have to be integrated, rather than pushed to the side.

“An ESG team in a separate ‘silo’ from the investment team may suggest that ESG considerations are less likely to be reflected in investment decisions,” Ms O’Neill said.

Do they publish regular reports?

In addition to the above, Ms O’Neill argued that the level of involvement that a fund displays within the wider ESG ecosystem is also something that investors should consider.

If a fund is regularly publishing engagement reports and impact statements, it’s usually a good sign.

If they’re engaged enough to be taking part of the conversation around ethical and ESG investing, they’re probably more engaged in the tangible realities than funds that aren’t.

Are their ESG actions externally recognised?

As well as being part of that wider ESG ecosystem, it’s worth considering whether a fund’s claims are recognised as credible by third-party operators in the space.

Ms O’Neill said it’s one thing to release regular reports about a fund’s ESG performance, but quite another to have the claims in those reports backed by a rating from groups like the Responsible Investment Association of Australasia.

She pointed to the RIAA’s Responsible Returns Investment Tool and the Ethical Advisors’ Co-op Ethical Fund Ratings as a good place for investors to start.

“With greenwashing on the rise, investors should ensure they are armed with the right information to support their investment decisions,” she said.