What is ESG Investing and ESG Funds in India

The full form of ESG investing is Environmental, Social and Governance Investing. Prior to ESG investing, investors used key financial ratios like Price to Earnings, Price to Book Value etc. But investors today are more interested in sustainable living and investing. This is why ESG investing is gaining momentum in India. Investors are no longer looking at just the bottom line. They are also looking at what a company is doing to protect the environment, society and promote corporate governance. ESG investing is also known as socially responsible investing, impact investing and sustainable investing. The concept of ESG investing is not just limited to ESG stocks. Even banks are joining the ESG investing trend with Green Fixed Deposits. The mutual fund industry is not far behind. In the last two years, nearly 10 ESG funds have been launched. The combined Assets Under Management of ESG mutual funds is a whopping Rs 12,698 crores. But just because the whole world is going gaga over ESG investing doesn’t mean you should also join the ESG investing bandwagon. We first need to figure out, what is ESG investing? Is ESG investing a trend or fad? or is it a solid investment strategy? Will ESG investing really work in developing countries like India? Let us find answers to all these questions…starting with what is ESG investing? 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.

What is ESG Investing?

The idea behind ESG investing is to invest in companies which practice responsible social behaviour. ESG investing seeks a positive impact on the environment, society, and promotes healthy corporate governance. 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.

Source: Sustaincase While ESG investing in India is in a nascent stage, globally ESG Investing is an old phenomenon. It was initially driven by institutional investors. But it has now started gaining attention amongst retail investors too. Let’s understand the constituents of ESG.

ESG Investing Factors:

Environmental Business activities of some companies can have a negative impact on our ecosystem. With ESG investing, the focus is on picking companies which are working towards minimizing environmental risks and liabilities. This includes the conservation of the natural environment. The Environment factor in ESG investing covers:

• Climate change and carbon emissions
• Pollution management
• Waste Management
• Environmental resource use and its impact
• Greenhouse gas emissions

Social Social issues play an important role in investments. It refers to the impact that companies can have on the entire society. This includes how a company treats people in society. Social factor in ESG investing covers:

• Employee relations and diversity
• Data protection and privacy
• Gender diversity
• Human rights
• Philanthropy

Governance 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. Corporate governance factors in ESG investing includes:

• Board structure and composition
• Stakeholder rights and relationship
• Bribery and corruption
• Executive remuneration
• Political contributions
• Whistle-blowing policies

All these factors carry 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 is the biggest cigarette company in India. Its market capitalisation is a whopping Rs 2,92,822 crores as on 16^th November 2021. 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 of what would otherwise have been a profitable investment? Let’s find that out.

ESG Investing – Compromising on Investment Returns? 

With so many restrictions, investors might think that ESG Investing does not look like a profitable investment strategy. 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 ESG 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 excluded.

Let us look at the performance of Nifty ESG Index against Nifty 50 Index. 

Past data shows ESG Index has outperformed Nifty 50 index 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’s a quick look at the top 10 companies in ESG Index along with their weightage in the Nifty ESG index as of October 2021. Top 10 companies of ESG Investing Index by weightage as of October 2021 –

Company	Weight %
Infosys Ltd.	6.76
Tata Consultancy Services Ltd.	4.94
Housing Development Finance Corporation	5.32
HDFC Bank Ltd.	3.16
Wipro Ltd.	2.86
HCL Technologies Ltd.	2.97
Bajaj Finance Ltd.	2.70
Kotak Mahindra Bank Ltd.	2.59
Tech Mahindra Ltd.	3.21
Titan Company Ltd.	3.07

The Nifty 100 ESG index was launched on 27^th March 2018 and currently has 88 constituents. The base date for calculating Nifty 100 ESG index is 1^st April 2011 and base value is 1,000. The Nifty 100 ESG index is dominated by financial services sector with a 28.83% allocation. Information and technology sector makes up 22.33% and Consumer Goods sector represents 12.64% of the ESG Index. Some key financial ratios of Nifty 100 ESG index are:

Key Financial Ratio	Values
Price to Earnings Ratio	30.76
Price to Book Value Ratio	5.89
Dividend Yield	1.23
Total Return – 1 Year	56.49%
Total Return – 5 Year	19.03%
Total Return – Since Inception	14.33%

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

When you are searching for stocks following ESG guidelines, reading and analysing the company’s annual reports is a must. 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. The below screenshot is from ITC’s annual report for 2021-22.

As you can see, ITC is actively involved in building a sustainable future by –

1. Reducing its carbon footprint
2. Deploying solid waste management system
3. Supporting 6 million sustainable livelihoods
4. Over 41% of energy consumed at ITC is from renewable sources.

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 stocks 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

In 2018, SBI Mutual Fund reclassified its equity fund as an ESG Fund. They converted SBI Magnum Equity Fund into an ESG theme fund. Thus, SBI Magnum Equity ESG Fund became the first ESG fund in India. Here is the list of top 10 companies SBI ESG Fund invests in –

The objective of ESG mutual funds is to invest in a diversified basket of companies following ESG criteria. Here is a list of all ESG funds in India.

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

Let us quickly take a look at the Best ESG Funds in India for 2022.

Best Performing ESG Funds	1-Year	3-Years	5-Years	Since Inception	AUM (Rs Cr)	Expense Ratio (%)
Axis ESG Fund	41.69%	0.00%	0.00%	36.25%	2,176	2.08%
ICICI Prudential ESG Fund	33.74%	0.00%	0.00%	37.05%	1,826	2.10%
Kotak ESG Opportunities Fund	–	–	–	–	1,793	2.03%
Quantum India ESG Fund	47.40%	0	0	27.22%	54	1.68%
SBI Magnum Equity ESG Fund	49.86%	22.06%	17.26%		4,529	2.11%

*Returns as on 15^th November 2021. This is not all. Mirae Asset Mutual Fund has also launched an ESG Exchange Traded Fund (ESG ETF). ESG ETFs help investors trade their ESG fund units on a real-time basis on the stock exchange instead of waiting for the day’s closing Net Asset Value. Here’s are some basic details on Mirae Asset ESG Sector Leaders ETF as of November 2021.

Date of Listing	24th November 2020
Face Value	Rs 18
Benchmark	Nifty 100 ESG Sector Leaders Index TRI
Minimum Investment	On exchange – In multiples of 1 unitFrom AMC directly – In multiples of 2,50,000 units
Creation unit size	2,50,000 units
Net AUM	Rs 134.82 Crores
Expense Ratio	0.44%

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.’ However, 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 the 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.

For the ESG investing strategy to work, you need to invest in companies that are genuinely concerned about social developments. You should strive to 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. Your aim should be to invest to generate returns in a socially responsible way.