Although the track record of a mutual fund scheme speaks for itself, rarely, it suggests anything about the future. As you may be aware, the investor community across the globe has always focused on a host of financial factors to evaluate the attractiveness of a company. However, doesn’t it boost your confidence if you know that your recommended funds invest in companies that pay a lot of attention to sustainability, besides being on a sound financial footing?
Lately, investors –– especially institutional investors––in the western economies, have become extremely sensitive to non-financial factors such as climatic changes, carbon emissions, biodiversity, human rights, labour standards, political environment and whistleblower policies to name a few while investing in companies. They have in a sense embraced ‘socially responsible investing’ or ESG (Environmental, Social and Governance) investing.
Deloitte expects the share of ESG Assets under Management (AUM) in the US to rise from 26% of the actively managed assets to 50% between 2018 and 2025. The popularity of ESG investing is growing in India as well. Some mutual fund houses have already launched ESG funds.
They are often categorized as open-ended thematic funds. The investment objective of an ESG Fund is investing in equity and equity-related instruments of companies that meet the Environment, Social, and Governance (ESG) criteria. So, typically companies engaged in the business of tobacco, alcohol, controversial weapons, gambling operations that compromise on ethics and cause harm to the society and the environment at large are excluded.
- You would agree that at a broader level, asset managers have a fiduciary responsibility while serving the interest of investors’ and community/society at large. While profit and growth are the most primary objectives of all businesses across the world, caring about the environment, society, and following good corporate governance practices is of utmost importance for all stakeholders and sustainable growth.
- The coronavirus pandemic has reinforced the need to adopt a responsible investing approach. Unless companies care about non-financial factors such as global warming, pollution, pandemics, geopolitical tension, etc. that potentially impact human life, it may not be a sustainable investment solution.
- Social issues affect the sustainability of a business. If the companies and investors give enough emphasis on the ESG factor, it is win-win for both and possibly optimises the risk-reward opportunities.
- Unlike other thematic funds that severely limit the universe of available companies to choose from, ESG theme is quite diversified and comprehensive––includes almost every industry except a few such as tobacco, alcohol, controversial weapons, gambling etc. This allows investors to take exposure to a variety of sectors of the economy, ethically. For e.g., a bank, an automobile company, a paint company, a technology company, an alternate energy company can be bought in an ESG Fund. Again, this list is not exhaustive.
- Including ESG analysis to routine financial analysis helps fund managers take an all-round-well-informed investment decision.
The crux of ESG investing is that various factors, such as revenues, profits, waste management, environment, data protection and privacy, executive compensation, lobbying, etc., that may appear unconnected are actually interconnected.
Hence financial advisors, consider recommending a worthy ESG Fund to your valued investors/clients. In recent years, the availability of alternative ESG information and tools has vastly increased to assist fund managers to take appropriate investment decisions.
Having said that, keep in mind the following points too…
- The popularity of investment themes often leads to a ‘me too’ behaviour of a different kind. Every other fund house would try to add an ESG Fund to its product basket. Hence, when you select an ESG Fund, read the investment strategy very carefully to assess how relevant the securities will be added to the underlying portfolio.
- An ESG fund must stick to the theme and not get swayed away from its mandate even if the theme underperforms the broader markets.
- Not buying a tobacco company may be a relatively easy choice, but how about a pharmaceutical company that discourages labour rights? Calling out such subtleties isn’t always easy. Hence, while recommending an ESG fund, you also need to understand the true character of the fund house, its core value system and investment philosophy. The character of the fund house decides how hard the fund management team can strive to capture all the relevant data to determine the overall performance of a company on the ESG criteria.
- If investors hope to see a vast difference in returns generated through ESG strategy and non-ESG strategy over the short-to-medium term (say 1-year, 2-year, 3-year time period), ESG investing may disappoint. The performance of an ESG Fund should be assessed over a longer period (over 5 years), which should be compared with the benchmark the Nifty 100 ESG Total Return Index.
- Lastly, do not assume ESG investing to be safe or low-risk. No! ESG Funds expose investors to high risk––given that a dominant portion of the assets is allocated to equity & equity-related instruments of companies fulfilling the ESG criteria.
As consumers across the globe are expected to become more sensitive to social and environmental factors post-pandemic than ever before, businesses will have to follow suit. An ESG fund can help investors align their portfolio to this change.
To sum up, here are five good reasons to invest in an ESG Fund:
- Offers a solution for socially responsible investing (by aligning with the investor’s personal philosophy — moral, beliefs, and social values)
- Fair diversification with, of course, Environment, Social, and Governance aspects being the focal points in the investment process
- Offers an avenue for better investment allocation
- Ensures liquidity and the risk is mitigated with robust investment processes in place
- The potential to clock sustainable long-term returns that can result in outperformance compared to its benchmark index
Financial advisors, therefore, could consider allocating a suitable portion of the investor’s/client’s investible surplus into an ESG Fund (taking into account their risk profile, broader investment objective, financial goals, and time-to-goals) and build wealth with eco-conscious, responsible investing.