ESG Investing - Environmental, Social, and Governance: Core Values of Investing in the Future

ESG Investing - Environmental, Social, and Governance: Core Values of Investing in the Future

?Paradigm Shift in Investing - Investors looking at an overall Impact rather than only Returns.

?Profits and returns are important, but Investors are looking at a total impact profitability for the company to make a difference and create a positive impact on the Environment, Social sector with the highest level of Corporate Governance and Transparency. ESG Investing is the way forward.

The demand for ESG investing has been increasing in India and other countries. The total investments are at USD 35 trillion or 36% of the total assets under management in 2020. Expected to reach AUM (Assets Under Management) in excess of USD 50 trillion by 2025 thereby representing more than one-third of the aggregate projected global assets. In India the total assets under ESG have reached in excess of INR 12,000 crores and are growing at a rapid pace. ESG investing is an investment process which takes into account sustainability or environmental, social and governance issues. With the impact that the world has witnessed in terms of overall climate change, ESG investing has been growing to a very large extent in order to create long-term impact on the value of the investment.

?Companies increasingly derive their value from intangible assets which are not captured in their balance sheets, like their people, use of natural capital and reputation. Adequate data is available by analysing this non-financial information captured by the ESG factors, not only to improve fundamental analysis, but also to assess the companies on risk dimensions. Companies that have poor governance, or which fail to consider environmental and social impacts, are unlikely to prosper over the long-term. Funds that do not take ESG factors into consideration are not fulfilling their fiduciary duty towards investors. It has now become a criterion for financial analysis of any company. Investors look for issues including climate change, social unrest, inclusion, and diversity, and firms that are more transparent in their actions.

?Some of the major criteria that is evaluated in ESG investments include resilience, resource utilisation, corporate ethics, human capital and occupational health and safety, land and biodiversity, and product governance. The Indian markets have evolved and come a long way in this regard as well. Investors have fairly wide choice in terms of overall number of stocks that they can invest in terms of the ESG framework directly of using dedicated mutual funds that invest in top ESG compliant stocks.

?NIFTY100 ESG Index is designed to reflect the performance of companies within NIFTY 100 index, based on Environmental, Social and Governance (ESG) scores. The weight of each constituent in the index is given a weightage based on ESG score assigned to the company i.e. the constituent weight is derived from its free float market capitalization and ESG score.

On the mutual fund side there are number of dedicated mutual fund schemes run by prominent fund houses. Some of the top ESG funds that investors can choose from are as follows:

?·??????SBI Magnum Equity ESG Fund: One of the oldest ESG funds in the Indian markets launched in January 2013, having assets under the management of INR 4,251 crores plus.

?·??????ICICI Prudential ESG Fund: Launched in September 2020, having an AUM of in excess of INR 1900 crores.

?ESG mutual funds offer investment avenues for retail investors, though they account for a tiny portion of the total industry at 0.3% of the total AUM. The majority of ESG investments at present are made by professional funds and large institutional investors, however with awareness increasing among Indian retail and HNI investors, retail investment in ESG fund and companies will increase over the years in India.

?Stock prices are dependent on a demand supply of investors. If there are more willing buyers than sellers, price will go up and if there are more sellers than buyers the price will go down. A perfect example is ITC, a company that has a strong Balance Sheet across business verticals has not really performed well as it is on an exclusion list for most overseas investors as it doesn’t meets the set standards of the environment due to the high amount of Social and Governance amount of revenue from sales of cigarettes and tobacco products.

?When making investment under the ESG framework, every company is assigned an ESG score.?Appropriate measurement parameter is used to estimate the extent of a company’s environmental and socially sustainable actions. The score can range between 0 to 100 and weighs the performance average using the three key factors- Environment, Society and Governance. If the ESG score of a company is high, it indicates good performance through suitable measures around these three factors. A low ESG score is an indication that the company is unable to take appropriate actions on these factors and may undergo losses because of regulatory punishments, environmental crises, etc. Credit rating agencies like S&P, Moody’s and Fitch, alongwith companies such as Bloomberg, MSCI, provide ESG scores for debt and equity of listed and unlisted companies.

?Some of the key reporting standards used by companies in India and worldwide are Carbon Disclosure Project (CDP), Climate Disclosure Standards Board (CDSB), Global Reporting Initiative (GRI), International Integrated Reporting Council (IIRC), Sustainability Accounting Standards Board (SASB), and Task Force on Climate-Related Financial Disclosures (TCFD) are the top ESG reporting standards.

?Under each of the heads of ESG, the following parameters is considered.

?

Environmental

Social

Governance

Climate change

Working conditions

Business ethics

Greenhouse gas (GHG) emissions

Equal opportunities

Executive pay

Resource depletion

Human rights

Board diversity and structure

Waste and pollution

Employee diversity

Bribery and corruption

Water and energy efficiency

Health and safety

Political lobbying and donations

Deforestation

Child labour and slavery

Tax strategy

Biodiversity

Community engagement

Compliance

? Philanthropy

Business Transparency

?ESG framework in India is starting to pick-up with investors as well as lenders like banks and financial institutions recognizing the importance and given adequate weightage and importance to lending and investing in companies with appropriate ESG frameworks. Over the next few years most companies will take adequate steps and put in place frameworks to be more ESG compliant and thereby create better overall impact on the whole. However, there are a few challenges currently faced in India for most companies who have or are looking to adopt the ESG framework.

?·???????Lack of Appropriate Data: From financial year 2022-2023, the top 1,000 listed companies in India by market capitalisation will need to prepare a Business Responsibility and Sustainability Report i.e. BRSR, containing detailed ESG disclosures. BRSR has to be a part of the annual report, which gets notified to the stock exchanges, published on official company websites, and separately provided to shareholders.?However, for this reporting standard to be adopted across the board would take a couple of years and thereby adequate information about the ESG activities is relatively difficult to find for most companies in India.

?·???????Lack of Appropriate and Measurable Standards for ESG: The Indian market currently lacks standardisation around ESG investing. Investors often use different names such as impact investing, sustainable investing, socially responsible investing, and also responsible investing measurement standards, and methodology used while reporting.?

?With what the world and humanity has experienced in the last 24 months during the pandemic, professional investors are not only looking at a return parameter but are looking for an overall impact, thereby embracing ESG framework which will be the future of investing in years to come. Hence in these turbulent times retail investors should keep an eye on well manged companies that have embraced the ESG framework and making a difference. As these are the companies that will attract large investors thereby growing in size and market capitalization resulting in wealth creation over the next few years.

?_Farzan Ghadially.