Is ESG Investing The New Trend?

Is ESG Investing The New Trend?


There is a small but growing group of investors who are now looking at investing in companies which have in place good governance practices regarding the need to preserve the environment and discharge their social responsibilities. The report underlines what ESG investing is all about and whether it is likely to gain in strength and popularity

Over the past two to three years, ESG investing has gained popularity in India. But first, what does ESG stand for? The letters indicate environmen- tal, social, governance. This type of investing is quite a new concept for Indian investors and has come in the wake of the fact that investors are now progres- sively evaluating non-financial factors as well while parking their funds. With the help of these non-financial factors investors or analysts analyse and identify the risk and growth opportunities in a company. ESG investing is also known as ‘sustainable investing’. Simply put, it means that investors would like to know if a company has sound strategies regarding the need for environmental protection, social responsibilities and proper governance.

Environment refers to the conservation of natural resources, waste management, animal protection and complying with environmental norms. Social refers to business and personal relationships. It includes working conditions, human rights, offering equal opportunities, philanthropy and corporate social responsibility. And governance refers to business ethics, compliance with accounting procedures, implementation of taxation and management rules and regulations, and corporate governance. Companies with strong ESG practice carry good reputation in the market. They send out a signal of being clean with the potential to grow and offer profitability to their shareholders. These types of companies have lower risk.

Conversely, companies with weak ESG face the risk of instability and losses. ESG-focused exchange-traded funds (ETFs) saw record inflows of more than USD 97 billion in 2020, and this trend shows no signs of slowing down this year, according to the data provided by Track Insight. In India there are 10 ESG funds available, including ETFs and fund of funds. These funds look for stocks of those companies which score high on ESG parameters. Every fund has unique operating methods – some offer global stocks, some are passively managed funds, some funds have exposure to both equity which follows ESG principles and also those which do not follow ESG principles as well as debt. Some funds solely invest in stocks which adhere to ESG principles, etc.

Application of ESG Theme in India


ESG mutual funds are categorised as thematic mutual funds that invest in companies which adhere to ESG principles. These are actively managed funds as they need formulation of strategies and analysis to invest in stocks of companies which are socially responsible. Some are passively managed funds which track the underlying index. In India, Mirae Asset ESG Sector Leaders ETF is a passively managed fund which tracks the Nifty 100 ESG Sector Leader index. Fund managers of different fund houses use distinct strategies while investing in ESG funds. Some fund managers invest in overseas’ stocks which comply with ESG principles. They don’t invest in companies that deal with products and services which are environmentally as well as socially harmful, as for example, companies producing tobacco, liquor, etc.

The following represent the top five ESG mutual funds available in India and their ratings as per Morgan Stanley Capital International (MSCI). 

It is as per the above scale that MSCI rates the funds. A company with rating of AAA and AA will be an industry leader and the funds’ investments tend to show strong and improving management of financially relevant environmental, social and governance issues. Such companies are very less prone to disruptions. A company with rating of A, BBB and BB could be termed average. Funds investing in these companies tend to show average management on ESG issues or a mix of both above- average and below-average ESG risk management. A company with rating of B and CCC can be termed laggard and it means funds investing in these companies are exposed to disruptions and don’t have adequate management of the ESG risk.

Benefits of ESG Investing
Conventionally, investors consider the financial aspects of a company while investing but recently have started considering non-financial aspects of the company in order to bring sustainability and steady growth in their wealth over the long term. A company with strong ESG management tends to have the potential to grow and is less prone to disruptions. ESG investing has given a way out to investors who want to align their portfolio with personal values. This type of investing has great potential to grow in India in the near future. This has also positively impacted the environment as well as socially responsible companies try to preserve the environment by complying with the norms. Compliance with accounting and taxation rules is also equally important in order to be an ESG company.

Challenges of ESG Investing in Indian
Conservative Mindset: Investors and fund managers think it is an added expense as they need to analyse and evaluate the ESG of companies which add up the expense and time spent. This is an obstacle for expanding ESG investing in India.
Lack of Track Record: In India, ESG investing is gaining popularity but there are no track records available on the basis of which investors can take decisions. This is because ESG funds have been launched only 2-3 years back in India.
Lack of Awareness: As ESG investing is yet to gain mass popularity in India, many investors and companies are unaware of this type of investing. It is essential to make investors more aware of the benefits of ESG investing.

The following charts depict the three months, six months and one year returns of the top five ESG funds:

Conclusion
ESG investing is all about how companies make money instead of how much money the company makes. It has been observed that companies with a higher ESG score have lower cost of capital than companies with lower ratings. This can result in more profits and, as a result, higher returns for investors. Nevertheless, we do not have sufficient data to prove that and hence before committing heavily on this theme it is advisable to wait for a couple of years to get a clear understanding of the returns. Many large-cap or flexi-cap funds might give you similar exposure that ESG funds have to offer. Therefore, it is best to stick to large-cap funds if you are not sure about investing in ESG funds. 

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