1. What is ESG and how fast is it growing in India and Globally?
ESG is the consideration of Environmental, Social and Governance factors in the investment process. It essentially focuses on how companies make money rather than just how much and tries to reduce exposure to companies that don’t manage their environment, social and governance risks well.
Globally, ESG investments have grown 36% since 2016, and the flow is maintaining its upward trajectory. The US and Europe continue to be the largest contributors, and, within Asia and the Pacific, Australia, Japan, and New Zealand are the major contributors with a quickly expanding share. It is worth highlighting that ESG investments have experienced a dramatic rise even during the COVID-19 pandemic. Globally, equity funds with ESG mandates achieved a record jump to USD 168 billion in 2020, almost triple the figure in 2019.
India has only 23 ESG focused funds even though India is the 6th largest economy in the world. Though ESG investments are at a very nascent stage in India, they are increasingly gaining traction in the country. Even the Economic Survey 2020–21 of the Government of India (GoI 2021) explicitly recognized the need to integrate climate and financial policies and identified a host of measures driving ESG investments in the country.
Source: Refinitv & Morningstar
Some of the other steps taken in this direction include:
NSE & BSE have become partners of the United Nations backed Sustainable Stock Exchanges Initiative, committing to promote sustainable investing through improved ESG disclosure requirements of listed firms
SEBI has mandated the inclusion of a Business Responsibility Report (BRR) as a part of the annual report for the top 1,000 listed companies
India has committed to be carbon neutral by 2070 in the recently concluded Glasgow summit
2. What is so good about ESG compliant companies?
Businesses are getting increasingly impacted by non-financial factors like climate change, sustainable farming/mining, data privacy & security, greater regulatory scrutiny, poor governance standards etc. Inability to manage these ESG factors well can have significant impact on the value of the firm for an extended period of time.
Some examples where significant wealth destruction has happened already include:
Satyam: One of the biggest corporate frauds of India, which led to the removal of a tech giant from Sensex, Nifty and tightening of corporate governance norms in India
Vedanta: Large Copper smelter ordered to shut down on environmental grounds in India
Facebook: Global tech giant faces public backlash and fall in profits due to data privacy infringement
Volkswagen: Millions of cars recalled by an automotive giant on account of falsified emission test results
Manpasand Beverages: INR 40 cr GST fraud wherein the company used fake invoices to claim input tax credit
On the contrary companies that rate high on ESG create lot of value on account of:
Lower cost of capital
Government support and subsidies
Sustainable top line growth with enhanced profitability
All contributing to premium valuation for the company on a long term basis.
This can also be seen in the long term return performance of ESG complaint companies where NIFTY100 ESG has outperformed both NIFTY100 and NIFTY50 over both 1 year and 5 year time periods as shown in the chart below. One should also note that the higher return comes at lower risk due to exclusion of unnecessary ESG risks. So on a risk adjusted basis, ESG companies fare even better than the broader market.
About the Author
I am currently working as a Research Analyst and Portfolio Manager at Green Portfolio. I have close to 7 years of experience in Equity Research and Investment Banking across firms like Edelweiss, Zanskar Advisors and Cognizant (Buy side M&A). I have completed my Engineering (Mechanical) from NIT Surat and MBA from IIM Shillong.
I have used publicly available information while writing this article.