GLOBAL - Hedge funds have little knowledge of the definitions of environmental, social and governance (ESG) beyond conflation, according to a study of ESG investment metrics by Lisbon-based Probus Sigma environmental investment research.
They confuse objectively based ESG metrics with socially responsible investment (SRI) and in some cases corporate social responsibility (CSR), the report revealed.
However, it says this is understandable in light of the SRI ratings industry's claims that ESG and SRI are one and the same.
The study adds: "Within the SRI ratings world, we see a repeat of the circularity that caused the sub-prime disaster - the rankings depend upon the ratings and the ratings depend upon fee income."
The report suggests that hedge funds that understand the real metrics of sustainability could take the lead in driving the sustainability agenda simply by obtaining a better grasp of what provably constitutes sustainable investment based on verifiable, objective risk metrics.
This would lower the investment risk and provide the much-needed next generation of sustainable investment, which firmly addresses carbon offset.
The report says: "The SRI Industry is notorious for developing what financial academia terms as pseudo metrics based entirely upon several hundreds of differing self-serving methodologies, which themselves are based on self-reported corporate information which is over a year old when published."
And much of the environmental reporting data released by some of the world's biggest companies is incomplete, inaccurate or deliberately distorted, according to a review of more than 4,000 CSR reports carried out by researchers from Leeds University in the UK and Euromed Management School in France.
Ralf Barkemeyer, a lecturer in CSR at Leeds and one of the team leaders, said: "The quality of environmental data in sustainability reports remains appalling at times, even today.
"In financial reporting, to leave out an undisclosed part of the company in the calculation of profits would be a scandal. In sustainability reporting, it is common practice."
Currently, all conservation and sustainable management of natural resources such as timber, marine and air rely upon private standards as measures of their sustainability.
While seemingly compliant with important ISO standards and making claims of robustness and rigour, these pseudo standards are not compliant and do not have even some of the basic entry-level checks and balances in place to be implemented as investment benchmarks, according to Probus Sigma.
In the case of voluntary carbon offset standards, the firm concluded, following a five-year-study, that these private standards lack any investment-grade rigour of process, operate in an entirely unregulated environment and merely provide a mechanism whereby the more unscrupulous may trade in carbon offset.
"Surely," the report says, "the time has come when the investment markets, especially hedge funds, need to understand what sustainability is and what it is not.
"Sustainable investment is not and never has been SRI or CSR-based - these pseudo environmental and social metrics just add substantial portfolio risk.
"Sustainability as defined by the original 1987 Bruntland Report has just three pillars - people, planet and profit.
"Sustainability in terms of a company's activities, measures the impact upon the environment and human kind related to the manufacturing process - it does not in any way seek to make moral judgments in terms of what product is produced.
"In other words, sustainability seeks to measure the process and not the product."