By the year 2050, 30 crore people would be living in areas that would be prone to coastal flooding, showed a recent study by US-based research institute Climate Central. The study predicts that Mumbai could flood at least once a year due to the rising sea level.
The effects of global warming are well known: shrinking glaciers, rising sea levels, floods, drought, wildfires, heat waves. Thus, global warming could have a direct bearing on the economy, society and ecosystem.
In response to these concerns, governments around the world are realising that climate change is a real threat and are committing to adopt measures to reduce emissions. Many countries like U.K., France, Spain, Denmark, among others, have committed to net zero emission by 2050. This means keeping the global warming ‘well below’ 2 degrees Celsius.
To achieve this ambitious target, many companies around the world are adopting sustainable ways of doing business. Investors too are realising that they need to put their money in companies which are making a real impact to reduce emissions and are high on governance standards.
Environmental, social and governance (ESG) funds are gaining traction
A 2018 survey conducted by Harvard Business School among asset managers showed that more than 80% now consider ESG criteria when making investment decisions and do so not only because clients demand but also because they think ESG information is material to investment performance.
This has led to a steady rise in sustainable funds which evaluate companies from environmental, social and governance lens. Such funds are quite popular in the developed markets. For instance, there are 303 ESG funds (including ETFs) in United States. Sustainable funds based in U.S received $21.4 billion flows in 2019, which was a fourfold increase in comparison to 2018 calendar year.
Morningstar research shows that investing for a cause doesn’t mean a compromise on return. In 2019, sustainable funds in U.S. have outperformed their conventional peers with 35% finishing in the top quartile of their Morningstar categories and 66% in the top half.
ESG in India
In India, Axis, SBI and Quantum offer ESG funds. Other fund houses are in the process of launching ESG funds. Besides asset management firms, Avendus offers Avendus India ESG Fund under an AIF structure.
While sustainable funds are being increasingly demanded by investors in developed markets, investors in India are yet to take a shine to such funds. There could be two reasons for this: low awareness and limited availability of ESG funds.
Amol Joshi of Plan Rupee observes that not many of his clients are seeking ESG funds. He believes ESG will pick up going ahead as the sensitivity towards environment concerns, social aspects and quality governance grows.
Gurgaon-based RIA Indresh Malik says that advisers need to play an important role in educating clients about this concept. He is optimistic about the future of ESG investing in India. “Lot of investors are keen to invest is such funds as it serves their duly purpose of long-term investing and helping more responsible corporates. We are dealing with clients who are already active with different social causes and few have made some allocations in ESG funds in their overall allocation. It will definitely pick-up in India also, as it addresses ESG factors which going forward should also reduce the risk associated with businesses (stocks picked by funds) and enhance returns due to better governance of those businesses.”
Also Read: Investing in ESG funds in India
Building an ESG portfolio
ESG should not be confused with sector funds. The universe of ESG stocks spans sectors and businesses. Of course, some companies are naturally excluded due to the products they manufacture. For instance, companies engaged in the business of tobacco, alcohol, controversial weapons and gambling operations are excluded as part of the first level of screening by managers. Controversial Weapons include chemical weapons, biological weapons, anti-personnel mines and cluster bombs. Managers then look at the company fundamentals and how each company fits into the ESG score. Active weights are assigned to each company based on how good they fare in ESG score and the growth prospects of the company.
Supporting ESG causes
For asset managers, investing in ESG compliant firm doesn’t merely means passive investing. They need to vote with their feet to spur companies to do what is in best interest of all stakeholders. Many large asset managers in U.S. are using proxy votes to press for better governance of environmental and social risks. Some of these issues revolve around better transparency around climate risk, protecting human rights risks in supply chains, environmental stewardship, gender pay inequality and measures to increase diversity and management of these risks.
How ESG fits into your portfolio
Bengaluru-based RIA Basavaraj Tonagatti is not seeing any interest in ESG investing, especially from retail investors. Due to the limited track record of ESG funds in India, he is not recommending these funds to his clients. He believes that it will take a lot of time for ESG to become mainstream in India as the penetration of equities is very low in comparison to global markets.
Four sectors (Financial Services, IT, Consumer Goods, and Oil & Gas) constitute 77% of The NSE Enhanced ESG Index weight. The stock level concentration is also high. The top ten companies (Reliance Industries Ltd, HDFC Bank, Infosys, HDFC Ltd, Tata Consultancy Services, Hindustan Unilever Ltd, Kotak Mahindra Bank, Axis Bank, Bharti Airtel, and L&T) make up for 60% of the index weight.
As of now, Basavaraj is of the view that ESG cannot form a core part of investors portfolio. Instead, he recommends investors to take some allocation as part of their satellite portfolio since ESG funds could bring concentration risk.
Summing up
Going forward, we believe more asset managers in India will incorporate ESG screening in their investment management strategies. A few fund houses in India are already signatory to UN Principles for Responsible Investments, an organisation which promotes the cause of ESG investing.
The growing awareness towards ESG issues means regulators, shareholders and stakeholders will put pressure on companies to improve their disclosures on issues which impact the society. This is surely a long-term trend; not just a fad.
