Every investor analyses a company before buying its stock. We evaluate its risk and returns to ensure that we are investing in the best company.
However, there are certain factors that can affect risks and return. But they are difficult to measure in monetary terms. These are referred to as Environmental, Social, and Governance (ESG) investing.
The world is changing. Investors have the power to make an impactful contribution by revising their actions.
How? Let’s find that out.
In this article, we will cover
1. What is ESG Investing?
2. Does ESG Investing mean we will have to compromise on our returns?
3. ESG Investment Research Process.
4. What are ESG Funds?
5. List of ESG Funds in India.
6. Key concerns and challenges with ESG investing.
ESG stands for Environmental, Social, and Governance.What is ESG Investing?
The idea behind it is to invest in companies which practice responsible social behavior. It seeks a positive impact on the environment, society, and corporate governance.
Investors have started applying these non-financial factors as part of their analysis process. They have started realising the importance to invest responsibly and smartly. Recent climatic and social havocs have caused a shift from traditional to ESG Investing. Many investors are interested in the impact their investments can cause on ESG issues.
Across the globe, we are seeing tremendous growth in ESG investing. A 2015 case study shows millennials are particularly interested in ESG investing. 88% of millennials are more likely to buy a company’s products if they are being socially or environmentally responsible.
ESG Investing is an old phenomenon. It was initially driven by institutional investors. It has now started gaining attention amongst retail investors too. However, it is relatively new for Indian investors.
Let’s understand the constituents of ESG.
ESG Investing Factors:
Business activities of some companies can have a negative impact on our ecosystem. With ESG investing, the focus is on picking companies working towards minimizing environmental risks and liabilities. This includes the conservation of the natural environment.
- Climate change and carbon emissions
- Pollution management
- Waste Management
- Environmental resource use and its impact
- Greenhouse gas emissions
Social issues play an important role in investments. It refers to the impact that companies can have on society. This includes how a company treats people in society.
- Employee relations and diversity
- Data protection and privacy
- Gender diversity
- Human rights
Governance risk is concerned with the way companies are run. Historically, corporate governance is covered under company analysis. This includes standards for running a company.
- Board structure and composition
- Stakeholder rights and relationship
- Bribery and corruption
- Executive remuneration
- Political contributions
- Whistle-blowing policies
All these factors carry have more moral value than economic value. Some investors see ESG Investing only as economic risks and opportunities. Others see them not just as opportunities but also as a matter of moral values.
For example, a health-related charity may find investing in a tobacco company unacceptable. But other investors may not share the same feeling. They may invest in the tobacco industry if they find them a profitable investment. For example, ITC and tobacco.
ITC’s FMCG operations include diverse products. But cigarette is their primary source of revenue. This negatively impacts social health and is against ESG investing..
So, if you are investing with an ESG mindset, you will not invest in ITC shares. Does this mean you are letting go on what would otherwise have been a profitable option?
Let’s find that out.
Does ESG Investing mean we will have to compromise on our returns?
ESG Investing might not look like a profitable investment option. However, research suggests that that is not the case. Generally, giving up certain categories of stocks (like ITC) should reduce returns. But in fact, ESG has delivered higher returns over certain periods if we eliminate companies with ESG issues.
In India, we have a Nifty100 ESG Index as an indicator comprising of ESG friendly companies. It is designed to track and reflect the performance of companies within the index.
To form part of the ESG Index, companies should qualify on the following standards:
- Stocks should be a part of NIFTY 100.
- Companies should have an ESG score.
- Companies with a controversy category 4 and 5 will be excluded. (We will learn about this further in this article).
- Companies engaged in tobacco, alcohol, controversial weapons, and gambling are
Past data shows ESG Index has outperformed Nifty Fifty over the past one and five-year period. ESG Index delivered a Compound Annual Growth Rate (CAGR) of 10.80% as of October 2020. Whereas Nifty 50 delivered a CAGR of 8.99% in the same period.
Here are the top 10 companies of ESG Investing Index by weightage as of April, 2021 –
|Tata Consultancy Services Ltd.||5.32|
|Housing Development Finance Corporation||5.12|
|HDFC Bank Ltd.||3.42|
|HCL Technologies Ltd.||2.73|
|Bajaj Finance Ltd.||2.44|
|Kotak Mahindra Bank Ltd.||2.41|
|Tech Mahindra Ltd.||2.4|
|Titan Company Ltd.||2.34|
ESG Investment Research Process
There is no standard format being followed to research ESG companies. Every investor and manager follow their own ideologies to select an ESG stock. However, you can follow these steps to invest in ESG responsible companies.
1. Review of company reporting
This includes reading and analysing the company’s annual reports. Various companies have now started reporting a separate section for their ESG contributions. Along with the annual report, read their Corporate Social Responsibility (CSR) reports. CSR reports are generally integrated as a part of the annual report or as a separate press release.
2. Review of external sources
Annual reports are prepared by the companies themselves. Hence, they might try to report on positive aspects only. Another way to check a company’s ESG contribution is by checking external sources. This includes reading news reports, NGO’s comments, etc. News reports usually are the best alternative source.
3. Controversy Analysis
This is a key component of ESG research. Your next step is to check a company’s involvement in controversies. This helps highlight incidents which can point to the lack of ESG compliance. At this stage of research, the investor can make a note of the potential risks they might face.
Nifty ESG Index follows the following method to highlight the reputational risk of such events.
Category 1 controversy events have the lowest impact. Whereas category 5 controversy events have the highest impact. Companies who fall under category 4 and 5 are excluded from the NIFTY100 ESG index.
4. Structural peer review
No company analysis is complete if you don’t conduct a comparative analysis. Your next step is to repeat the same steps on their peers. For example, if you evaluated Kotak Mahindra bank’s ESG contributions, review other private banks as well to form a firm opinion.
5. Form your final opinion
Form a structured report once you finish evaluating potential companies. You can also draw a SWOT matrix to analyse a company’s ESG strengths and weaknesses.
Based on your research, form an opinion to select the best ESG contributor.
Investors have the means to drive change. You can have a significant influence on corporates and leaders. Investing in a company that is ethically driven to a greater cause is one of the best ways to do our bit.
If you find this method of selecting ESG stocks complicated, you have another option to invest responsibly. The rise of ESG investing has also led to rise of various new ESG funds. Here, the responsibility to invest your money in ESG compliant companies is on the fund managers.
Let’s have a brief look at ESG funds and their performance.
ESG Funds in India
ESG Investing is not limited to buying and selling individual stock to build a portfolio. Many mutual fund houses have launched ESG funds in India.
A mutual fund manager looks for a company with potential earnings, management quality. For the ESG fund, the fund manager looks for companies that score high on the environment, social and corporate governance.
One flaw in ESG Investing is that there is no uniform research standard. Every fund house has adopted their own methods to determine which stocks will make the ESG cut.
Six ESG funds were launched in India in 2020. Net inflows in ESG funds increased from Rs. 22 Crore in March 2020 to Rs. 678 Crores in March 2021.
In 2020, there were 17 ESG funds rolled out globally compared to ten ESG funds in 2019.
ESG Funds in India and their performance
India currently has ten ESG funds out of which seven were launched after June 2020. Some of the newly launched ESG funds are
- ICICI Prudential ESG Fund
- Aditya Birla Sun Life ESG Fund
- Kotak ESG Opportunities Fund.
Top 10 companies SBI ESG Fund invested in are –
The objective is to investments in a diversified basket of companies following ESG criteria. Here is a list of ESG funds who share the same objective.
List of ESG Funds in India
|Sr. No.||ESG Funds||Inception Date|
|1||SBI Magnum Equity Fund||May-18|
|2||Quantum India ESG Equity Fund||Jul-19|
|3||Axis ESG Equity Fund||Feb-20|
|4||ICICI Prudential ESG Fund||Oct-20|
|5||Quant ESG Equity Fund||Oct-20|
|6||Mirae Asset ESG Sector Leaders ETF||Nov-20|
|7||Aditya Birla Sun Life ESG Fund||Dec-20|
|8||Kotak ESG Opportunities Fund||Dec-20|
|9||HSBC Global Equity Climate Change Fund of Fund||Mar-21|
|10||Invesco India ESG Equity Fund||Mar-21|
Satyabrata Mohanty, Senior Portfolio Manager of Aditya Birla Sun Life AMC said –
‘ESG is a powerful concept that has been well accepted globally. In India too we see the growing prominence of this theme. Corporate India has enough success stories on ESG. Managements have shown deeper commitment towards all stakeholders. Companies following ESG practices build a long-term enduring business model. It leads to superior risk-adjusted return.’
There are few shortcomings to ESG Investing.
Key concerns and challenges with ESG investing
Investors have finally started looking beyond financial statements. However, there are some concerns with ESG investing.
The main challenge is a lack of quality data. There can be companies who claim to be ESG compliant but are not. Transparency and ethical reporting of data is of utmost importance.
Another challenge is to bring some clarity to the selection process itself. The uncertainty makes the investment process tricky.
Invest in companies that are genuinely concerned about social developments. Invest in companies which are trying their best to truly move the needle when it comes to ESG issues. The best way to identify ESG companies is to follow the above-mentioned steps. And most importantly, be aware of which companies is in news and for what reason.
For example, in 2007, Google became carbon neutral.
Anand Mahindra has set a target to achieve carbon neutrality by 2040. The Mahindra & Mahindra group is taking steps to apply a decarbonisation framework to all its companies.
As Robert Swan once said, ‘The greatest threat to our planet is the belief that someone else will save it.‘
You might feel that one small investment would be an insignificant contribution. But that is not so. Imagine what could happen if every investor starts investing their money in ESG responsible companies. Thousands of such responsible investing will lead the money flow to responsible companies.
ESG based investment strategy has gained popularity across global investors. You are fortunate enough to be an investor. The next most impactful step you can take is to invest smartly and responsibly.
Open your FREE Demat account with Samco today and start investing to make an impact. Investing to generate returns in a socially responsible way.