Can you make money from ESG investing?

© Venkatasubramanian K Can you make money from ESG investing?

The Rs 30 trillion Indian mutual funds (MF) industry may have seen five ESG-themed MF schemes rolled out so far in 2020. But a wave of ESG investing has been sweeping global markets for some time now.

Data from research firm Morningstar Investment Adviser showed that in October, global assets under management (AUM) with ESG portfolios hit a high of US$1.2 trillion – a quantum increase from $530 million five years ago. Bloomberg reports state that there were 17 ESG exchange traded funds rolled out so far in 2020, compared with 10 in all of 2019. This launches make October the best-ever month for inflows since 2013.

The theme reflects environmental, social and governance standards of a company. ESG investing means getting into companies that come with clean managements, manage their social responsibilities well – for instance, they maintain gender diversity – and do not pollute the environment.

In India however, ESG funds are still in a nascent stage. But investor interest is increasing. “There is awareness about ESG in every aspect of conducting business. Society wants to see businesses being more responsible in these areas and it is already visible in lending practices and investor participation globally,” says Mrinal Singh, deputy CIO, ICICI Prudential mutual fund.

Are there enough ESG-compliant companies in India?

Consider this. The Nifty 100 index has 100 companies. But the NSE100 ESG index, which is a subset of Nifty 100 index, consists of only 88 companies.

The lack of depth in the market for ESG-friendly companies is also mirrored by India’s low rank in the Environmental Performance Index (according to researchers in Columbia and Yale universities). At present, India ranks 168 out of 180 companies in the ranking released in June.

Another issue is the absence of a common set of ESG guidelines. At present, the capital market regulator, Securities and Exchange Board of India (SEBI) has not laid out any framework or a minimum threshold that companies must meet to be able to qualify as an ESG-compliant company. Different fund houses are free to develop their own internal guidelines to identify ESG-compliant companies. Guidelines will prevent what is referred to as “greenwashing” (conveying false information that a company is environmentally sound). In India, the Nifty ESG index is within the Nifty 100 construct, but based on weightages of the ESG score.

ESG: A passing fad or a promising future?

Typically, small investors and most distributors or financial advisors focus on returns. But fund houses believe that investors would eventually demand for their money to be invested in companies that meet certain standards.

Foreign institutional investors and high-net worth individuals are pushing local advisors or fund managers to integrate ESG scores into investing metrics. “We are seeing companies toe best practices in ESG on their own or, at times, there is a nudge from stakeholders,” explains Singh.

For instance, the recently published sustainability report by Larson & Toubro states that it does not manufacture cluster munition, which addresses some ESG concerns of analysts. Likewise, a fund manager (who did not want to be quoted) believes that ITC could demerge the cigarettes business from the consumer segment, as it is a drag on valuation from an ESG perspective. Note that companies engaged in the businesses of tobacco, alcohol, controversial weapons and gambling operations are excluded from Nifty ESG.

Also listen: Simply Save Podcast | Why ESG Investing is Gaining Popularity?

Jinesh Gopani, head of equity, Axis mutual fund, which has its own methodology for ESG evaluation says, “In the ESG scale, the aspect that is more relevant to a company is given higher weightage. For example, in the case of IT and banking firms, we give higher weightage to governance than environment as the risks to earnings from the latter are limited in these sectors.” This trend shows that investors are demanding accountability not just on a company’s profits, but best practices on governance and social issues too.

Can ESG and non-ESG investing co-exist?

If fund managers, especially those who have launched ESG funds, speak so highly of ESG investing, what stops all existing diversified equity funds from turning ESG-compliant?

Global investment management firm BlackRock Inc’s Chairman and CEO Larry Fink said in a letter addressed to the fund house’s clients early this year that by the end of 2020, all active portfolios and advisory strategies will be fully ESG integrated.

India has a long road ahead in sustainable investing, given the host of mid and small-sized companies that may find it challenging to comply with such norms. But, experts say that the Indian MF industry is moving in the right direction.” As more schemes raise money, investor awareness would improve. Companies that have low ESG scores could lose prominence or importance in the investment horizon, even if they generate higher profits. Such companies stand the risk of losing capital flows, especially from FIIs,” says Kaustubh Belapurkar, director-Fund Research, Morningstar Investment Adviser. Some leading proponents of sustainable investing go a step further to say that compliance will determine even the cost of capital for companies.

The key is to integrate ESG scores into investing, across mutual fund schemes, which although an arduous journey, could be worth the while towards sustainable investing.

This could well be profitable as a basket of ESG-compliant companies have a track record. The combined assets under management of exiting ESG funds in India are at just Rs 810 crore at the moment. India’s tryst with ESG funds has just started. This pales in comparison with the corpus that ESG funds abroad manage (3475 funds with assets under management of $ 1.24 trillion).