Understanding ESG Investing - Brown Living™

Learn how to invest sustainably and make informed decisions with this comprehensive guide to ESG investing. Explore Brown Living's Brown Journal now!

The ongoing pandemic has made us conscious about the consequences of reckless harm we have done to nature. Not only to nature but even among the human beings, the ones already oppressed are being increasingly exploited. With people becoming more and more aware about the wrong doings going on since years, everyone wants a remedy. In India, more and more people have started becoming aware about investing through mutual funds.

There are a plethora of mutual fund schemes and categories available today. Apart from debt and equities, one can also invest in funds exclusively investing in another asset classes like gold. Various new concepts in mutual funds are coming up.

ESG Investing is a step towards building a sustainable future and promoting healthy and socially viable competition among businesses with an opportunity for investors to earn great returns without doing any harm to the environment.

What is ESG Investing?

Traditional investment analysis parameters such as net profits, return on capital employed, etc. are quantitative. ESG investing is an add on that quantifies the qualitative aspect of business.

Three pillars of ESG Investing are Environment, Social and Governance. The mutual fund houses in India invest in the companies which ticks maximum number of boxes coming under this criterion. From an investor’s standpoint ESG investing is to invest in the companies which have been doing business the right way. Here we try to explain a bit about each of the pillars.

1. Environmental:

This refers to the companies which do not inflict harm to the environment. The basic premise behind investing in such companies is that the future will demand us to prosper but not at the cost of environment. The companies considered are satisfying maximum number of these points:

  • Take the steps to protect the environment
  • Make sure there is no generation of environmental externalities and if any they are not such that it may turn into unanticipated costs for the company in future.
  • Make sure their raw materials sourcing and manufacturing does not harm the environment.
  • Are conscious about climate change and are trying their best to tackle it.
  • Do not pollute the environment and try to process their waste in a way that it does not become a liability for the nature.
  • Continuously try to improve the environmental conditions over and above required CSR expenditure.
  • The carbon dependence and carbon intensity of the business model is low or nil.
  • Try to use water efficiently.
  • Does not harm the biodiversity and land.
  • Capitalizing on clean Tech, Renewable Energy, etc.

2. Social:

Employees are the heart of every business. For sustainability, it becomes extremely essential to protect their rights and at least provide them the best conditions for work. Socially developed organizations treat their employees with high respect. This gets reflected in the firm’s long-term success. The companies which are socially developed:

  • Adopt measures to keep occupational accidents at bay
  • Employee safety is their priority
  • Treat employees equally
  • Provide a fair work-life balance
  • Over and above meeting the regulatory requirements, the ethical standards and practices displayed by the company should be very high.
  • Safety of the products is high.
  • The employees and the stakeholders in general have an access to finance, healthcare, communication, etc.
  • Thus, the second pillar talks about the safety and upliftment of all the connected stakeholders.

3. Governance:

This is a key issue that analysts have been tracking even before the introduction of ESG Funds. This involves tracking the practices of the company Governance India falls behind in this particular aspect as compared to other western countries. We have seen many failures and frauds on the governance side such as Satyam, IL&FS and Yes Bank to name a few. While analyzing for Governance, mutual fund houses study companies which have:

  • Clean corporate Governance.
  • No whistleblowing events.
  • The top management has not sanctioned extraordinary pay for themselves which does not match with the industry standards.
  • Company maintains clean and transparent accounting.
  • The top management of the company scores high on ethical practices.
  • The company has high tax transparency.
  • Strict Governance Norms: Board independence, stronger audit committees and stricter disclosure norms.

What is the Rationale to Invest in ESG Funds?

Many a times the factors which do not look to be affecting the business might prove to be fatal for business in the long term. We know how important climate change is as a factor when the president of the world’s most powerful country decided to join the Paris Climate Change Accord the very first day of becoming president. Nowadays companies have become aware about the importance of creating a sustainable future for the generations to come.

Nearly 71% of the world’s top 500 companies have opted to externally audit their environment impact numbers.

A study by Unilever in 2017 revealed that one third of their customers were choosing to buy brands which they believed were doing social and environmental good. People have understood that the companies not focusing on these ESG aspects won’t be able to sustain for a long term.

With an increased demand, the stock prices of the ESG compliant companies are expected to soar. These increased stock prices will gradually make the ESG non-compliant companies to start focusing on ESG thus creating a company ecosystem with sustainable development at its core.

How Do Fund Houses Select Companies?

The process of selecting the correct ESG compliant company is very exhaustive and detailed. The mutual fund house arrives at a set of companies for final screening out of which some are added to their portfolio. After the first stage of screening, they arrive at an ESG risk score for various companies.

The lesser the score, the better is the ESG compliance of the company. For example, the ESG score of greater than 40 is considered much more risky and the inclusion of company should be avoided. An ESG score of less than 10 is an ideal company which is supposed to be included.

Different sectors have different ESG scores. For example, within the cement category, Ultratech has the best ESG risk score. Asian Paints is doing the best in ESG compliance among its peers.

To make sure, the company isn’t just relying on PR stunts to show itself ESG compliant, the fund houses undertake a periodic review of the constituent companies and make sure they fall within their pre specified category of the scores. It may happen that there is a significant difference between the score of the company in the past and present.

Government Push:

The Government is indirectly promoting the ESG Business model through a range of incentives. Following are some of them:

  1. Environmental: Fame 2 Scheme for EV Adoption, Urea Subsidy, custom Duty Elimination on Solar tempered glass, exemption from road permit for EV and CNG vehicles, renewable energy subsidies, etc.

  2. Social: Stamp duty rebate for property owned in women’s name, financial inclusion, affordable housing, etc.

  3. Governance: There have been many positive outcomes of the government appointed committees such as the Kumar Mangalam Birla Committee, Kotak Committee, etc.

These steps signify government’s interest in promoting ESG compliant companies. This sounds as assuring as it is!

How to invest in ESG Funds in India?

There are eight asset management companies offering ESG investing in India. You can choose whether you want to invest in actively managed funds or passively managed ESG Funds. Funds where the management team of the fund actively makes decisions about how to invest the firm’s money are known as actively managed funds. The funds which simply follow the specified market index are known as passively managed funds. The passively managed ESG fund mimics Nifty ESG Index. The pool of fund houses offering ESG funds is short. In this case, we suggest investors to decide on the basis of fund managers experience and expertise.

You can invest in all the ESG Funds through Tarrakki. The Tarrakki team suggests ESG funds for the ones having a long term horizon. Systematic Investment Plan in ESG Funds is a great way to accumulate wealth over time. With longer horizon, one can accumulate enormous wealth by simply investing small amount every month.

For example, one can accumulate around Rs. 50,00,000 after 20 years of disciplined monthly investments of just Rs. 5000 assuming a decent rate of return of 12% year on year.  Thus what may seem like a miniscule amount might prove to be a huge blessing in long run.

Note: Ideas taken from MSCI ESG Ratings Methodology.

This blog has been co-written by Brown Living and Tarrakki.

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