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
- Employee relations and diversity
- Data protection and privacy
- Gender diversity
- Human rights
- Board structure and composition
- Stakeholder rights and relationship
- Bribery and corruption
- Executive remuneration
- Political contributions
- Whistle-blowing policies
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 –
|Tata Consultancy Services Ltd.
|Housing Development Finance Corporation
|HDFC Bank Ltd.
|HCL Technologies Ltd.
|Bajaj Finance Ltd.
|Kotak Mahindra Bank Ltd.
|Tech Mahindra Ltd.
|Titan Company Ltd.
|Key Financial Ratio
|Price to Earnings Ratio
|Price to Book Value Ratio
|Total Return – 1 Year
|Total Return – 5 Year
|Total Return – Since Inception
ESG Investment Research ProcessThere 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 reportingWhen 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 –
- Reducing its carbon footprint
- Deploying solid waste management system
- Supporting 6 million sustainable livelihoods
- Over 41% of energy consumed at ITC is from renewable sources.
2. Review of external sourcesAnnual 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 AnalysisThis 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 reviewNo 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 opinionForm 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 IndiaESG 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 performanceIndia currently has ten ESG funds out of which seven were launched after June 2020. Some of the newly launched ESG funds are 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
|SBI Magnum Equity Fund
|Quantum India ESG Equity Fund
|Axis ESG Equity Fund
|ICICI Prudential ESG Fund
|Quant ESG Equity Fund
|Mirae Asset ESG Sector Leaders ETF
|Aditya Birla Sun Life ESG Fund
|Kotak ESG Opportunities Fund
|HSBC Global Equity Climate Change Fund of Fund
|Invesco India ESG Equity Fund
|Best Performing ESG Funds
|AUM (Rs Cr)
|Expense Ratio (%)
|Axis ESG Fund
|ICICI Prudential ESG Fund
|Kotak ESG Opportunities Fund
|Quantum India ESG Fund
|SBI Magnum Equity ESG Fund
|Date of Listing
|24th November 2020
|Nifty 100 ESG Sector Leaders Index TRI
|On exchange – In multiples of 1 unitFrom AMC directly – In multiples of 2,50,000 units
|Creation unit size
|Rs 134.82 Crores
Key concerns and challenges with ESG investingInvestors 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.