How ‘ethically conscious investing’ put Vanguard on ropes

ASIC deputy chair Sarah Court said Vanguard ‘had expressly that it would exclude bonds that had significant business activities in fossil fuels’. Picture: NCA NewsWire / Ian Currie

With ‘green’ investing at a crossroads, the decision by the corporate regulator to haul the giant Vanguard group to court over alleged greenwashing is set to become a milestone for investors.

Vanguard, a hugely successful non-profit fund manager, is perhaps the only group in the market that has the potential to offer a rival to the dominant industry funds sector in superannuation.

But the public reputation of the index funds leader is now under fire.

Somehow, Vanguard has managed to get attacked by both sides when it comes to ESG (Environment, Social and Governance) investments.

First, Vanguard has fallen foul of the Australian Securities and Investments Commission, which is concerned it exaggerated just how green some investments are in reality.

According to ASIC, the fund in question – The Vanguard Ethically Conscious Global Aggregate Bond Index Fund – held exposures that literally shouted from the rooftops the nature of their activity, such as The Abu Dhabi Crude Oil Pipeline. As Sarah Court, ASIC deputy chair put it, the fund had “said expressly that it would exclude bonds that had significant business activities in fossil fuels”.

Second, Vanguard, has angered environmentalists and the green lobby in recent times.

Initially, the group was lambasted for not doing enough on climate issues. However, last year it tiptoed into the debate with some changes to its coal investment policy. But not long afterwards the group appeared to double back on taking any stance in the debate when it exited the Net Zero Asset Managers Initiative. By this stage, Vanguard had unwittingly prompted the birth of a high-profile climate activist website devoted solely to Vanguard bashing: Vanguard-S.O.S.

The irony is that Vanguard – a US-based mutual – has built a tremendous $10 trillion business around the world by keeping things simple. The core of its product list is based on traditional mirror index funds that simply reproduce the results of a wider market such as the ASX 200 or the S&P 500.

Moreover, the majority of the money placed with Vanguard is in these ‘plain vanilla’ funds.

However, with the creation of products such as an ‘Ethically Conscious’ fund, the manager moved away from its core discipline and created a product based on an index that was constructed with the aim of excluding certain investments. It does not take a qualification in risk management to know once you twist the indexing formula in this fashion the chances of something going wrong escalate considerably.

It must be all the more galling for Vanguard then to find out that the money is flowing out of this sector over the last year as the tide turned on ethical or ESG investments.

Investors have spurned the sector for several reasons, including anti-ESG factions in the US that have gained power in certain states. Separately, there has been a shift away from green investments by those fund managers who were worried they could not stand up to increasing scrutiny from regulators.

Calastone, the funds group that monitors investment flows, recently reported that June was the worst month ever for investment outflows from ESG funds worldwide.

In fact, Vanguard in Australia is one of the groups facing a specific challenge. In May this year, Morningstar research house noted outflows from green investments at Vanguard “was at odds with its sustainable peers”.

For Vanguard Australia the timing of this court action is dreadful. The group has built up a strong following especially among financial advisers in recent times.

More recently it has put enormous resources into the launch of a superannuation product aimed squarely at everyday investors in the retail market.

You have to wonder whether management at Vanguard might think that ESG has hardly been worth the effort.