The new buzzword in equity markets across globe is ESG investing. The ESG theme, which stands for environmental, social and governance conscious companies, has gained significant interest in the developed markets such as US and Europe. While it is still in the nascent stage in India with only a handful of ESG mutual fund schemes, many asset management companies are queuing up to launch them in the near term.
What are ESG schemes?
ESG schemes look to invest in companies that meet high environmental, social and governance standards. Even in their daily business operations, these companies show a relatively high degree of responsibility towards all stakeholders- employees, suppliers, dealers or anyone connected with the company’s activities. The managements of such companies are empathic to the environment and are mindful of ethical business practices. Typically, such companies transcend boundaries of mere robust profit growth to self-imposed ethical standards in business operations.
The concept has evolved over time but finds mention in the late 20 century. To give a few examples, investors excluded companies that were manufacturing tobacco from their portfolio. In the 1990s, John Elkington, co-founder of the business consultancy SustainAbility spoke about ESC (environment, social and corporate governance). He indicated that one must look at the “triple bottom line,” which refers to statement of results in three areas profit, people, and the planet.
Why invest in ESG companies?
Market veterans believe that ESG firms show tremendous resilience through highs and lows of economic cycles, thereby leading to sustainable growth. They display relatively low volatility in business due to lower incidence of mishaps and accidents, controversies and enjoy greater loyalty from customers, employees and may be conscious of the need to conserve capital. This could prove beneficial to long term equity investors.
ESG investing is based on the premise that as large retail investors invest in such companies, it would support stock valuations. Indirectly, it would nudge the corporate world to act responsibly from a social, environmental and governance perspective.
Factors such as climate change, shifts in societal preferences and governance issues do pose risks to corporate earnings and thus to investors in stock markets. Companies that are aligned with ESG norms usually have lower risk of losses due to these factors. Thus, investing in firms with a high ESG score could translate into enhanced value for investors in the long run.
Are there enough ESG compliant companies?
Media reports suggest that there has been a surge in sustainable investing in the US and Europe since the outbreak of the Coronavirus pandemic. At the end of the second quarter 2020, investors have poured nearly $250 billion in the US, which represents 20% of the total market. In Europe, the size of assets into such sustainable investing schemes is thrice that of the US. As per Morningstar Direct, the number of ESG schemes rose from 1168 in 2009 to 3054 in 2019.
The trend is gaining momentum in India too. Both the Bombay Stock Exchange and National Stock Exchange have ESG index funds, which have after due diligence categorised companies under this theme. These indices would help benchmark mutual funds and structured products.
Of course, investors must note that companies in this category mostly under large-cap category with strong business practices and environmental compliance. For instance, ESG schemes would omit tobacco major such as ITC Ltd, but include a host of front line pharma and banking companies Dr Reddy’s Ltd, Housing Development Company Ltd, Larsen and Toubro Ltd, Infosys Ltd and Axis Bank among others. Note that these companies have actually contributed to the national and social cause during the pandemic by either allocating financial resources, manufacturing health care products or by offering facilities for Covid-19 care.
In fact, the ESG philosophy is gaining appeal among young investors who are conscious of the need to preserve environment and adopt transparency in business practices. Even the number of ESG conscious firms are growing as investors, regulators and stakeholders are demanding accountability not just on profits, but governance and social compliance.
Do they offer better returns to investors?
Mutual fund ESG schemes have been allocating resources to companies that have been embracing the philosophy consistently over several years. They usually toe the line of benchmark indices with a marginal outperformance at times. What’s important is that they are resilient during times of crisis times and typically tend to bounce back soon.
Further, analysts of ESG investing eliminates risk to returns from malpractices such as audit queries or lack of environmental compliance in case of starting new factories or sheer tweaking to manufacturing practices to circumvent rules of business. As a result of these filtration practices, the earnings tend to be sustainable over long periods of time.
For a layman, it is very difficult to keep track of these factors of all the companies listed in India. One can overcome these limitations by investing in an ESG Fund offered by mutual fund houses. Currently there are three schemes in this space - Quantum India ESG Equity Fund, SBI Magnum Equity ESG Fund, Axis ESG Equity Fund and very soon ICICI Prudential too is launching an ESG Fund. The New Fund Offer period for this offering is from September 21, 2020 to October 5, 2020.
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