An ESG report discloses the Environmental, Social and Corporate governance practices of an entity. Investors can analyse the report to view the benefits of the ESG activities of the entity as they look for investment opportunities. Investors now recognise the potential financial benefits of sustainable and responsible practices by an entity.
Research indicates that businesses adhering to robust ESG practices typically enjoy customer attraction and a competitive advantage. This translates into the generation of favourable risk-adjusted returns, stemming from reduced capital costs and enhanced operational efficiency, ultimately leading to improved profitability. Additionally, ESG-compliant companies often demonstrate greater resilience during economic downturns. Financial markets are also conscious of the long-term repercussions of ESG factors; thus, assessing and managing these risks has become a fundamental part of the investment decision-making process. This risk refers to the potential negative impact on companies’ financial performance and valuation due to factors related to sustainability, ethical practices, and corporate governance.
In July 2019, select fund houses in India introduced ESG as an investment theme. The combined Assets Under Management (AUM) for all ESG funds amounted to approximately Rs 2,332 crore. It is observed that there have been no new ESG issuances in the past two years, in contrast to the six issued in 2020. According to a CNBCTV18 report, ESG funds are still in an early developmental phase in the Indian market. The collective AUM of these operational funds in India amounted to Rs. 10,243 crore as of March 29, 2023. A significant portion of these funds is linked to the NIFTY 100 ESG, a benchmark comprising 89 listed companies.
As of June 2023, the Nifty 100 ESG Index has demonstrated a Compound Annual Growth Rate (CAGR) of 13.7 per cent over the past five years. While this rate is relatively modest compared to the ESG AUM figures observed in Europe and the US, it is anticipated to increase in tandem with the rising awareness and heightened interest among investors in sustainable and responsible investment practices.
In India, a prevailing ESG approach involves exclusion, where investors choose to omit particular sectors from their investment portfolios, constraining the range of their investments. Those with firm convictions against specific industries, citing their perceived adverse effects on the environment or society, may find these funds appealing due to the intentional avoidance of such sectors. According to CRISIL MI&A Research, the nine ESG funds exhibit the highest exposure to the lending and information technology (IT) sectors, collectively constituting 44.1 per cent of their holdings. Among the top 10 ESG-performing sectors based on CRISIL’s scores, these funds predominantly have significant investments in three sectors: IT, lending, and auto OEM. Notably, almost 58 per cent of these funds’ holdings are concentrated in the top 10 ESG-compliant sectors, while the bottom 10 sectors account for only 9 per cent of their investments.
As mentioned, the Indian market exhibits a notable concentration, with the top five sustainable funds representing 87 per cent of the total assets in the sustainable fund category. The largest among them, the SBI Magnum Equity ESG strategy, the oldest sustainable fund, constitutes 45 per cent of the overall sustainable assets.
In its March 2023 board meeting, the Securities and Exchange Board of India (SEBI) introduced regulatory requirements pertaining to ESG disclosures, ratings, and investments. One important rule says that ESG schemes have to give at least 65 per cent of their assets to publicly traded companies that carry out “Business Responsibility and Sustainability Reporting” (BRSR) Core 10 audits. Even though the SEBI recently granted mutual fund approval to introduce six new categories under the ESG theme, outflows from sustainable funds persisted for the second consecutive year. In the June 2023 quarter, there was an outflow of Rs. 5.9 billion, following a similar outflow of Rs. 4.7 billion in the preceding March 2023 quarter, primarily attributed to profit-booking.
ESG investments face certain limitations due to their relatively recent emergence, lacking a universally recognised global standard. Unlike other investment sectors, there are no established benchmarks that investors can use to check, analyse, and compare ESG funds for decision-making. Furthermore, the dearth of available data poses a challenge for investors seeking to conduct thorough analyses. Existing long-term data does not convincingly position ESG funds as financially viable options. Such misleading conclusions may discourage investors from considering these funds as viable investment choices.
To enhance ESG fund investments, several key considerations can be employed. Firstly, thorough research is essential to identify funds with a robust ESG strategy aligned with individual values. Investors should assess the fund’s methodology for incorporating ESG criteria, ensuring it aligns with their ethical preferences. Diversification is crucial for the risk management of funds. Allocating investments across different sectors and regions helps mitigate concentration risk and enhances the overall resilience of the ESG portfolio.
Furthermore, engaging with companies and fund managers through active ownership can drive positive change. Investors can participate in shareholder initiatives, advocate for improved ESG practices, and contribute to sustainable corporate governance. Staying informed about evolving ESG regulations and reporting standards is vital. Regulatory developments can impact the performance and transparency of ESG investments.
Finally, staying abreast of emerging ESG trends and innovations is essential. The landscape of sustainable investing is dynamic, with new opportunities and challenges continually emerging. Regularly reassessing and adjusting the ESG investment strategy ensures alignment with evolving market dynamics and contributes to a more resilient and impactful investment approach.
Dr. Neha Seth, Associate Professor, Symbiosis Institute of Business Management, Noida, Symbiosis International (Deemed University), Pune.
Dr. Said Siddiqui, Professor, Department of Management Studies, Jamia Millia Islamia, New Delhi