Home / Opinion / Views /  ESG funds: the irresistible combination of ‘do good’ and ‘do well’

Stewardship in social-ecological systems and governance outlines the achievements of most prestigious institutions with integrity. In this regard, let’s recount an episode a few years ago when the Church of England withdrew from a major mining project in Odisha. Activists believed that the project, besides ruining the Niyamgiri mountain’s ecosystem, would deprive the Dongria Kondh tribe of crops and water from the hills. For the Church of England, respect for human rights was sacrosanct.

Today, we find scores of investors standing firm on the principles of sustainability. While ambition and innovation are essential for the success of businesses, investors too desire that these attributes be regulated by core ethical principles. Both businesses and investors find common ground for long-term association. It explains why investors are getting increasingly drawn to companies that align their operations to minimize environmental, social and governance (ESG) risks. They engage fund managers to assess long-term business models and select the stocks of those companies which do not conduct activities detrimental to society, threaten the ecological balance or fail on governance.

This is the universe of ethical investments, or ESG funds, that is poised to challenge conventional investment strategies.

Walking down the ethical path doesn’t mean trading off profits. Investors have faith that ESG funds can endure market vagaries and offer long-term risk-adjusted returns. They believe ESG-compliant businesses enjoy longevity and can raise foreign capital, as opposed to those that cut corners for quick profits and remain on an unstable footing.

Typically, ESG funds exclude companies with poor records of waste recycling, water consumption, energy preservation, and those that do little to minimize carbon footprints. It needn’t be reiterated how unethical industrial practices exacerbate ecological and socioeconomic problems through landslides, soil erosion, floods and droughts. But such screening isn’t limited to the environment.

From a social perspective, ESG fund managers filter sectors like gambling, tobacco and liquor. While investors might be sceptical of such sectors, they may still be considered if companies in these fields do enough to prove their commitment to sustainability. Also, asset managers identify companies with a history of worker protests, exploitation of labour, frequent strikes and work stoppages. All these impact valuations negatively.

Also, attention is paid to sound governance, which encompasses the traditional values of board independence, shareholder rights, transparency, disclosures, whistle-blower policies, workplace safety and compliance with regulations, among other aspects.

Indeed, it’s fascinating the way the ESG funds story touches various segments of our society. Coffee lovers, to cite an example, have reason to be proud. In 2020, Starbucks issued sustainability bonds to develop eco-friendly stores, eliminate food waste and promote reusable packaging. It’s a heartening example of a company choosing to be a warden of the environment. Asset managers are only too willing to include such companies in their portfolios.

That said, ESG ratings of mighty organizations can be downgraded should they disregard material-investment risks like water scarcity in their plants. Six years ago, a beverage company learned this the hard way after its bottling plant in north India was asked to close for its over-pumping of ground water.

So, where does India find itself in the ESG firmament? The Nifty 100 ESG had 88 companies from 16 sectors in January last year. Information technology, consumer goods, financial services and energy made up 74% of the index.

Inflows into ESG mutual fund schemes increased 76% in 2020-21 to 3,686 crore. By 2030, India’s ESG-themed investments are projected to increase to 30%—as a share of overall fund volume—and reach over 20 trillion, according to ESG Risk Assessment & Insight, an ESG rating company.

Regulations are believed to be delivering the right outcomes. Recently, the Securities and Exchange Board of India introduced new requirements for sustainability reporting by listed entities. The Business Responsibility and Sustainability Report will encourage companies to disclose their adoption of responsible business practices. Such disclosures will help investors make better investment decisions. And ESG rating agencies will now have relevant information to assess the performances of companies.

India Inc is becoming increasingly conscious of the ESG paradigm. In November, 24 companies signed a declaration on climate change by voluntarily pledging to move towards ‘carbon neutrality’. Companies are constituting ESG committees at the board level (Infosys is an example) to demonstrate their commitment to climate change, diversity, energizing local communities, clean technology, data privacy and so on.

India is still in the early stages of its ESG evolution. But a realization has started to sink in that creating a climate-resilient world calls for collective and concerted effort, and also for making appropriate investment choices. Investors aren’t faced with the dilemma of ‘principles or profits’ anymore. The two act like mutually complementary forces. Some funds that ‘do good’ also ‘do well’, which is why we’re witnessing a pivotal shift towards an embrace of ESG investments.

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