Know all about ESG investing
In July 2020, JPMorgan, the mammoth financial service company released a report stating that the coronavirus pandemic and the trail of destruction left in its wake could spur a greater shift to socially responsible investing.
JPMorgan’s co-heads of sustainability research Jean-Xavier Hecker and Hugo Dubourg wrote, ““The COVID-19 crisis has not only brought on the greatest recession since World War II, but investors are also calling it the 21st century’s first “sustainability” crisis and one that has renewed the focus on climate change, acting as a wake-up call for decision makers to prioritize a more sustainable approach to investment.”
Over the last few years, the world of investing has been witnessing a slow yet steady undercurrent of change in the values that drive investment. The coronavirus outbreak has served to accelerate the popularity of ESG investing. This paradigm of investing entails selecting investable companies that meet pre-determined attributes with respect to environmental, social and corporate governance for generating risk-adjusted long term returns.
The core values of ESG investing
Environment: It is no secret that all forms of business activities today have some environmental implication and what with the burgeoning problems of climate change and deterioration in ecosystems and the quality of air and water, corporations have a duty to adopt measures that mitigate the negative environmental impact of their operations. Investing in companies that are making a conscious effort to switch to more environment-friendly practices is one of the core components of ESG investing.
Social: This refers to a company’s social ethos that is at the heart of the dynamics that plays out in its relations with various stakeholders in the ecosystem such as employees, customers, suppliers, business partners. The idea is to pick companies that follow socially responsible policies, clean management practices and prioritise the well-being of their human capital assets to foster a positive work environment within and outside the organization.
Corporate governance: This criterion acts as a lens for evaluating the company’s management systems and business ethics as well as its ability to manage long-term risks and opportunities. For instance, does the company maintain absolute transparency in its accounting methods, does it have an existing regulatory framework that can prevent bribery, corruption or any kind of illegal practices? Good corporate governance practices keep the objectives of shareholders aligned with that of the company and that can go a long way in generating value for shareholders.
Why you should invest in ESG funds?
While socially responsible investing is a fairly new trend in India, but the global investor community has been privy to the benefits of ESG investing for a while now. The coronavirus pandemic has added more believers to the league of ESG investing - as per the data published by EPFR, socially responsible investing (SRI) or ESG investments have seen record inflows of $168.74 billion in 2020 versus $63.34 billion in 2019.
Until recently, ESG investments were bogged down by the reputation that investors had to compromise on profits because the pool of companies eligible for investment would be limited. But the assumption is slowly being proved as fallacious - study published in 2015 by the University of Oxford and Arabesque Arabesque Partners titled “From the Stockholder to the Stakeholder” summarized approximately 200 scientific sources on the economic effects of sustainability and found that good ESG performance is linked to better stock performance. In India, the NIFTY 100 ESG Index has outperformed NIFTY 50 by delivering superior 5-year returns in 2020.
Environmental, social, and governance criteria serve practical purposes beyond concerns of companies being ethically aligned with that of investors. By using ESG filters, investors can avoid companies whose practices could be the harbinger of major troubles – like the Volkswagen emissions scandal that sent stock prices into a free fall and triggered losses in billions of dollars. Taking ESG factors into consideration can help investors in avoiding companies with red flags.
ESG investments in India
In India, previously there were no uniform standards for ESG investing and fund houses formulated their own criteria to determine which stocks made the ESG cut. However on May 10, 2021, the Securities and Exchange Board of India (SEBI) issued a circular notifying new disclosure norms on sustainability related reporting for the top 1,000 listed companies by market cap by FY23. The reporting will now be under a new business responsibility and sustainability report (BRSR) format, the SEBI circular said.
A report published by The Hindu elaborated that companies will need to provide an overview of their material environmental, social, governance risks and opportunities and approach to mitigate or adapt to the risks along with financial implications. Sustainability related goals and targets and performance and environment-related disclosures covering aspects such as resource usage (energy and water), air pollutant emissions, greenhouse emissions, transitioning to circular economy, waste generated and waste management practices and bio-diversity may have to be provided, it said.
The SEBI mandate is expected to simplify and bring in greater transparency that will enable investors and financial institutions to assess and pick corporations that genuinely follow ESG principles. The lack of quality data on whether companies actually complied with ESG practices and the extent to which they delivered on their promises has been a major challenge in the arena of ESG investing. While mutual fund houses applied differing philosophies entailing exhaustive research to gauge whether a company fulfilled the ESG criteria or not, ascertaining whether ESG principles have actively been followed or they have been deployed as a marketing ruse was a struggle. The SEBI’s new mandate can make ESG investing simpler and inject more accountability into the systems.
• With climate aggression starting to impact human lives, corporations will have to make ESG practices an intrinsic part of their business. Investing in ESG companies means you are putting money into companies that are focusing on long-term sustainability and reducing risks in the long-term as opposed to companies that are non-ESG compliant.
• Mutual funds are the best way to foray into the path of ESG investing. This is because fund houses screen companies at multiple levels to ensure that companies are truly ESG-compliant and this saves the investor from the hassle of having to do painstaking research on their own to check whether a corporation is following ESG practices or not.
• Companies engaged in the businesses of tobacco, alcohol, controversial weapons and gambling operations are not considered ESG-compliant.
This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund.