What is ESG Investing?
Climate emergency was the word of 2019 and Coronavirus would probably be the word of 2020. Both are alarming crisis and crises tend to propel trends. The global uncertainty and human vulnerability have undoubtedly accelerated the inclusion of Environmental, Social and Governance (ESG) investing into the mainstream.
ESG investing was just one among all themes up until now. Now, the scenarios have changed and the connection between material risk and returns is becoming crucial for investment decisions. ESG investing and sustainability are not just fancy words. The impact of ignoring the sustainability aspect of a business has a material and a long-lasting impact on the business, the investors and all the other stakeholders.
ESG is an additional toolkit to analyze the companies based on qualitative aspects which are often missed out in the financial statements. It is impossible to quantify the impact of climate change in the balance sheet or the importance of business ethics in a profit and loss statement. The global pandemic of 2020 has been an eye-opener to assess the company not just on its financial performance but also on its sustainability and longevity. ESG analysis, therefore, can no longer remain on the back burner. But what is ESG investing?
ESG stands for Environmental, Social and Governance. Any company which is doing well today and hopes to sustain this progress in the future will be mostly compliant with ESG. ESG funds are portfolios that invest in equities, bonds of companies that are assessed on environmental, social and governance factors.
These companies or shares pass through stringent tests on sustainability to meet the ESG criteria. ESG factors provide insights into the quality of a company’s management, culture, risk profile, and other characteristics.
If you are someone looking to invest in companies that have sustainability agendas and are environmentally conscious, then ESG fund might interest you. In this article, we will cover more about what you should know about ESG funds as an investor.
Breaking Down ESG
A company is called ESG compliant if it satisfies all the conditions of environmental, social and governmental benchmarks. ESG funds assess these companies strictly and only select shares of companies for the portfolio that are ESG compliant in the true sense.
- The E of ESG
E stands for the Environment., essentially aiming towards preservation and conservation of natural resources.
India is getting more serious about climate change and pollution control than ever before, a company that has best practices when it comes to the protection of the environment around its factories and places of work is less likely to be impacted by regulations that could force plant shutdowns, etc. as compared to those which do not regard the impact their business has on the environment.
Besides regulatory, it is imperative for businesses to adopt greener practices while operating for the sustenance and upkeep of the environment and our resources for future generations as well. It is safe to say, that companies that are “E” conscious not only have a good cause at heart but also remain shielded from regulatory misconducts and hence show good potential.
- The S of ESG
S stands for social. At the core of any business are its people. Companies that are socially developed treat their employees with the utmost respect and takes care of their wellbeing. For instance, employee safety, measures against occupational hazards, fair treatment of all genders, etc, is what a socially conscious organization demonstrates.
Apart from improving the work-life balance of their employees, socially responsible companies also extend their goodwill to various socio-economic causes, by means of CSR initiatives. Needless to say, socially responsible companies garner a lot of appreciation and trust from employees and other stakeholders alike.
- The G of ESG
G is for Governance. This is the base, the foundation by which the company is judged. However, merely following GAAP standards and meeting checkboxes on audits, do not qualify a company to be compliant with regards to governance.
What it means is that when it comes to financial disclosures, the company is ethical and transparent and can uphold the highest standards of governance consistently. Since they take governance seriously, they remain unaffected by any regulatory reforms, no matter how tough they are. Investing in such companies, for you as an investor, thus becomes safe to a large extent.
ESG And The Indian Market.
ESG has been big globally and has doubled over the last four years with the assets under management (AUM) of $ 40.5 trillion in 2020. Some might have thought that ESG is a bull market luxury till 2019; however, ESG has shown its true mettle in 2020 amidst the crisis.
Since the inception of the Nifty 100 ESG Index in 2011, the index has outperformed with a return of 10.6% versus the traditional Nifty 100 Index return of 9.1%. The drawdown, which measures the decline from a historical peak, is lower for the Nifty 100 ESG Index at -27.1% as against -29.1% for Nifty 100 Index.
The AUM of INR 45 billion is currently managed under ESG funds as per AMFI and will likely grow further as both funds and investors learn and adapt to this compelling evidence. This will certainly push the companies to follow better governance practices, adopt fair employee
policies, safeguard the environment and practise ethical policies. There are several factors that have contributed to the growing interest in ESG funds in India. These factors are categorized as push or pull factors.
- Push Factors
Factors such as regulatory requirements including mandatory business requirements are push factors.
For example, regulatory requirements such as top 500 companies by market capitalization are required to drive the investor’s interest.
- Pull Factors
These factors include certain phenomena, such as increasing foreign investor interest. Foreign institutional investors are increasingly moving their portfolios towards companies that have sustainable businesses.
With the corporate government governance issues on the rise, the Indian is likely to show high adoption towards ESG investing. Moreover, for India, governance takes priority over social and environmental aspects since minority shareholders stand to lose in the absence of governance. Thus, pressure from the investors’ community is likely to prompt companies to change and become more ESG compliant before regulations kick in.
Future of ESG in India
One of the challenges that Corporate India has to contend with and will continue in the future (which is great for investors) is the fact that regulations are going to get stricter and adherence to them is going to get tougher.
Be it environment norms or impact on society or actual accounting bells and whistles. The Regulators are going to come down hard on companies who flout the rules and penalize those who are out of line. If the company adheres to the highest standards of E, S, and G then there is a three-fold advantage of investing in those companies; They do not need to incur any additional costs and are on a safer wicket if the Regulator tightens norms.
An ESG compliant company can take advantage of the situation to increase market share while other non – compliant companies struggle due to violating strict regulatory protocol. Being ESG compliant enhances the reputation of the company multi-fold – not only amongst investors – but customers and stakeholders alike.
With stakeholders’ capitalism that is long-sighted and focuses on serving all the stakeholders, trending and getting embraced by investment experts across the globe. ESG is proving to be a catalyst to shift from shareholders capitalism, which is myopic and focuses only on the needs of shareholders, to a more holistic stakeholder’s capitalism. ESG is good for companies, investors and the society; thereby achieving a triple bottom line and could be the “new normal” in the world of investing.