For several decades, most investors have bothered only about one component of investing i.e. returns. And statisticians have considered asset price volatility as the basis for calculating the risk involved in investing. Hardly a few investors really cared about how the profits were earned, who paid the price for them and more importantly what was the price paid.
As a result, we usurped mother earth. Global warming, caused by rapid deforestation and greenhouse gas emissions, is just the tip of the iceberg — there are deeper ramifications. And unless we prioritize our social, economic and environmental goals, the future generations are likely to pay a heavy price for the so-called ‘development’.
The COVID-19 pandemic has taught us a lesson on being sensitive to the environment (E), choosing our leaders thoughtfully (G), and the role all stakeholders of the society (S) need to play. It also reminds all of us — the citizens, governments and corporates — to be cognisant of our ecosystem and being socially responsible.
Good health, an effective policy framework, and profit growth in an ethical way can’t be taken for granted. All stakeholders need to be more conscious of their responsibilities towards society, planet earth, and good governance matters!
Note: For illustration purpose only
(Source: Quantum ESG Fund Presentation)
You see, when you invest, a business has a good chance of sustaining in the future often when it…
✓ Conserves the environment;
✓ Honours its commitments towards the society; and
✓ Follows transparent, fair and good governance practices
That’s why the Environment, Social, and Governance (ESG) factors are the three pillars that encompass a lot of material issues impacting the overall performance of the company and its growth.
As you may know, quite a few Public Sector Banks (PSBs) reporting frauds and irregularities in their accounts have seen their stock prices going down as much as 20% in a day and 50% in a month. One of the so-called fastest-growing private sector banks nearly went belly up and was saved only due to the intervention of RBI. Similarly, a private sector housing finance company accused of siphoning off money got hammered in the stock market and eroded shareholders wealth by 34% in a single day and 52% in a month.
Mind you, these aren’t just isolated cases…
Sin goods companies operating in the industries such as liquor, tobacco and gambling can sometimes appear cheap. But the question is, do they score on the ESG score. Also, their susceptibility to sudden changes in government policies does not make them very reliable from a wealth creation standpoint.
Similarly, coal mining companies, thermal power producers, companies manufacturing environmentally hazardous chemicals may trade at cheaper valuations, but may not make it on the ESG investing parameters.
In various countries, the government has imposed heavy restrictions on industries and companies polluting the environment, which has weighed on the sector and the stock prices of certain companies.
Conscious citizens have also staged protests against the expansion plans of mining companies harming the environment.
The drug regulation department of certain countries has pulled up non-complying pharma companies, potentially causing more harm than wellbeing.
Likewise, clashes between workers and company management not paying heed to socio-economic issues have caused sharp and substantial shocks to stock price.
As against this, the companies having a strong ESG compliance record have often displayed far better sustainable growth and generate wealth for investors with ethical policies and risk management systems in place.
ESG complying companies are…
- Sensitive to environmental issues
- Transparent (an essential quality of governance)
- Treat people with equity and dignity
- Follow good labour practices, including the compensation policy
- Hear out views of its stakeholders
- Treat minority shareholders well
- Give importance to privacy and data security
- Give weight to the independence of the board
- Do not encourage corruption and fraud practice
- Are socially responsible
Such companies with a robust business model and ethical processes and systems in place, usually, generate sustainable profits and healthy cash flows. And whenever they desire to raise capital, find it relatively easy and do it at very competitive costs.
Thus, many a time such companies enjoy premium valuations and tend to outperform broader markets over the long-term with far better stability than the others.
According to Bloomberg Intelligence, ESG AUM is expected to grow to USD 53 trillion (from USD 38 trillion) by 2025. This means, nearly one-third of the total global Assets Under Management (AUM) would be ESG AUM by 2025.
Moreover, the debt-oriented ESG AUM is expected to swell five times from the current USD 2.2 trillion to USD 11 trillion by 2025. So far, Europe and the U.S. have been at the forefront of the ESG quest. In the Asia-Pacific region Japan, in particular, is expected to catch up very fast over the next few years.
In India as well, the ESG theme has been gaining ground of late. This is quite evident from the fact that six fund houses have launched an ESG fund each over the last one year. Today, there are a total of nine ESG mutual fund schemes on offer, and their performance has been quite appealing.
Table: Performance of ESG Funds
|Scheme Name||Absolute (%)||CAGR (%)|
|6 Months||1 Year||2 Years||3 Years|
|Quant ESG Equity Fund||48.7||—||—||—|
|Quantum India ESG Equity Fund||22.6||70.4||—||—|
|SBI Magnum Equity ESG Fund||18.3||59.5||16.9||13.0|
|Axis ESG Equity Fund||15.6||50.6||—||—|
|ICICI Pru ESG Fund||14.1||—||—||—|
|Kotak ESG Opportunities Fund||—||—||—||—|
|Invesco India ESG Equity Fund||—||—||—||—|
|Aditya Birla SL ESG Fund||—||—||—||—|
|Mirae Asset ESG Sector Leaders FoF||—||—||—||—|
|Nifty 100 ESG Index – TRI||19.4||65.6||20.3||—|
Direct Plan and Growth Option Considered
Data as of May 11, 2021
(Source: ACE MF, PersonalFN Research)
The SBI Magnum Equity Fund (incepted in January 1991) reclassified and repositioned as SBI Magnum Equity ESG Fund in May 2018 is the oldest ESG Fund in the country.
In India, although ESG funds have been investing across the market capitalizations, their portfolio predominantly has a large-cap bias. Information Technology, Pharmaceuticals, Consumer Goods and Private Sector Banks dominate the sector allocations. In other words, despite being thematic funds, ESG funds offer a fair bit of diversification and their large-cap orientation makes them a lot more stable, especially in volatile market conditions.
Globally as well, ESG funds have been investing in sunrise sectors making the best use of technologies. You would also them taking exposure to renewable energy, green transportation, wastewater & effluent management, organic chemistry, agriculture and water transportation amongst others. Out of these, green energy and green transportation have been the most favoured ones. The tech companies facilitating the green transformation are also in demand.
In India, currently, there are limited investment options that qualify on the ESG parameters — sectors such as renewable energy and green transportation amongst others. However, with the growing number of companies going public, possibly the basket for ESG will grow. Among the existing players, visionary managements would diversify into emerging areas that have a tremendous potential to attract green and responsible investors.
That said, remember that ESG investing is not purely a ‘top-down approach’ (as in the case of other thematic funds), but also encompasses a ‘bottom-up approach to investing. When a mutual fund scheme follows this theme, it sets the performance matrix accordingly; whereby it can measure the sustainability or the future preparedness of the companies under consideration, recognising their role in the larger community, the risk involved, the competitive advantage, while ultimately aiming to accomplish the stated investment objective of long-term capital appreciation.
Here’s why investing in the ESG Funds is worthwhile:
- Offers a solution for socially responsible investing (by aligning with your 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 deliver long term risk-adjusted performance as compared to its benchmark.
Nevertheless, keep in mind that investing in companies having a sustainable future won’t automatically safeguard you from the risks associated with markets and stock selection.
If you are hoping to make some positive difference to the world by investing in a socially, environmentally responsible and ethical way, consider investing in ESG Funds. But ensure you have the stomach for high risk and an investment time horizon of at least 5 years.
This article first appeared on PersonalFN here