Are you considering an environmental, social and governance (ESG) investment? Do you know how to evaluate what you might be buying? An OSC study examined the influence of ESG factors on retail investor decision making. It found ESG ratings greatly influence investor decisions, but these ratings are difficult for people to understand.
On this page you’ll find
What are ESG investment funds and what did the OSC want to explore?
Many people are interested in environmental, social and governance (ESG) investment funds. ESG investing allows you to choose investments that align with your priorities and avoid those that don’t.
ESG funds use different strategies to achieve their ESG objectives. Some funds focus on a specific area of ESG, rather than all ESG issues. Other funds may cover more than one ESG focus. For example, a fund may be focused on both governance and the reduction of carbon emissions.
Any time you invest in anything, including ESG investment funds, it’s important to know what you are investing in.
There are various ratings for ESG investments. But what do these ratings mean? And how effective are these ratings to help you evaluate potential ESG opportunities?
The OSC examined the influence of ESG factors on retail investor decision making. The report looked at greenwashing in investment funds, which occurs when a fund’s disclosure or marketing intentionally or inadvertently misleads investors about the ESG-related aspects of the fund. And it looked at the motivation and behaviours of retail investors in relation to ESG investment funds.
Read the full report: A Behavioural Insights Analysis of the Effects of Environmental, Social, and Governance Factor (ESG) Disclosure and Advertising on Retail Investors
What did the OSC study find about ESG ratings?
An OSC experiment found ESG ratings were one of the most important attributes influencing investor preferences when selecting investment funds — second only to a fund’s past performance. The strength and format of the ESG ratings (letter grade and number of stars) also greatly influenced investor choices.
The study also highlighted challenges investors face in evaluating the ESG components of investment funds and the difficulties of assessing different types of ESG ratings including:
- A lack of standardized definitions of ESG factors.
- A lack of standardized methodologies to measure ESG factors.
- A lack of a definition of sustainability.
- Differences in ratings and rankings variables, and how easy they are to understand.
- Different values, beliefs, and motivations of retail investors.
While retail investors may not fully understand ESG ratings, they use these ratings when selecting ESG investment funds. There are different types of ratings and a lack of clarity around what the ratings mean.
Investors who are driven by their values are particularly at risk. These investors are more willing to sacrifice returns, including paying higher MERs and accepting potentially lower performance, to support funds they believe are making a positive impact.
Why are ESG ratings a concern for regulators?
The OSC is concerned about the lack of transparency of ESG ratings.
Incorporating ESG factors into investment decision making is a key issue for capital markets and investor protection. There are many ESG investment funds and investors rely on ESG information when they’re making investment decisions. There are also pressing sustainability objectives in the global economy.
The lack of transparency in ESG definitions and ratings can lead to greenwashing. Investors may incorrectly believe they are investing in companies that align with their ESG values.
Stakeholders, including authorities, could help retail investors by working to:
- Increase clarity in ESG definitions and ratings – Potential standardization of ESG ratings and more clarity could eliminate confusion and prevent greenwashing. Investors could more accurately compare investments if ESG ratings were consistent across different funds and products.
- Educate investors – Improve retail investors’ understanding of ESG investing through education and outreach, including the differences between ESG risks and impacts, as well as being able to identify signs of greenwashing. This would help investors make decisions that truly align with their values.
- Strengthen advisor proficiency – Promote financial advisor training on ESG investing to better support their clients.
These findings of this research will help the OSC and stakeholders understand the influence of ESG factors on retail investment decision making, including susceptibility to greenwashing.
