What is ESG fund?

ESG funds are generally portfolios of equities and bonds for which environmental, social and governance factors have been integrated into the investment process. ESG investing is popular with the names of sustainable investing, socially responsible investing and climate friendly investing all around the globe. Although there are no hard and fast norms on what comprises ESG companies, each fund follows different parameters to assign scores to companies on ESG to select stocks. At the time of investing, ESG funds select those companies which score high on ESG parameters although these parameters keep on changing. Before going in-depth about these funds, let us first understand the three components of ESG:

Environmental factors: In ESG, E stands for the Environmental factors which motivate the companies/institutions to preserve the natural resources by reducing the over exploitation of them. We are all now aware that India is getting stricter on pollution control in order to save the deteriorating condition of Indian climate. Companies having best practices to save the environment by using eco-friendly production techniques are not likely to be impacted by regulations. On the other hand, government is asking some plants to shut down their operations because they have violated the rules of pollution and carbon emissions. Keeping aside the regulatory norms, it is the responsibility of corporates to adopt more eco-friendly practices in order to save the dying planet. Companies which are “E” conscious have a good cause and are trying to shield the environment so that it can be transferred safely to our next generation.

Social factors: The next element of ESG is S which implies Social factors. The base of any company is its human resources i.e., people. Companies which are socially responsible, develop the capacity of their employees. They take care of their well-being and have zero tolerance policy against discrimination based on sex, caste and creed. These companies put a great deal of efforts for the safety of their employees. Besides developing their employees, these companies also take care of society as a whole; they keep setting part of their wealth aside on a yearly basis. They extend their support in the form of Corporate Social Responsibility (CSR) for various socio-economic causes.

Socially conscious companies get lot of appreciation and trust from employees and society alike.

Governance factors: The last element in ESG is G which means Governance. There are certain measures like GAAP, annual social audits, etc., which judge a company’s governance factors. However, merely complying with these standards does not necessarily mean that a company is holding highest ethical standards. It means that company should be honest while disclosing its financial position and follow a transparent policy of governance. Investors can confidently invest in these companies as they are best governed companies.

ESG funds are becoming popular among investors who have a larger purpose to serve the society by cutting down the carbon emissions and trying to contain all kind of pollutions while not compromising on financial returns. In India, as of now there are three ESG funds schemes —

*ICICI Prudential’s scheme has also entered the ESG market recently. More are expected to follow.

What changes can it bring?

Government is not asking chemical business, refining business or thermal power business to quit but what government is trying to do is to make them socially responsible by imposing rules. Companies should make their production process eco-friendly and make use of technology in an efficient manner so that no harmful elements are drained into waterbodies or spread in air. Companies which do not follow environmentally sustainable models will find it difficult to raise debt and equity in the markets. If we look at globally, there is massive attitudinal shift among investors who do not want to invest in companies which are not socially responsible. This same attitude is gradually forming pattern in India, but we have a long way to go. Due to ESG framework, companies will be compelled to abide by ethical practices, better governance and eco-friendly processes which will help both society and investors.

Indian Scenario

The Assets Under Management of INR 60 billion is currently managed under ESG funds as per AMFI and will likely to increase further as both funds and investors adapt to these practices. In coming years, regulations will get more stringent, posing a challenge to Indian corporates to adhere to these ESG frameworks. However, if they sincerely comply with regulations then it will be a win-win situation for companies and Government as Government does not have to incur costs on the process of scrutiny and companies will get advantage to increase market share as non-compliant companies will be forced to shut down. Being ESG conscious increases the goodwill of a company amongst its stakeholders. The Nifty 100 ESG Index which was made to reflect the performance of companies within Nifty 100 index based on the ESG score, has outperformed its parent index Nifty 100 across various timeframes. The Nifty 100 ESG Index has given a Compounded Annual Growth Rate (CAGR) of 4.6, 9.3 and 7 per cent in the last 1, 3 and 5 years while the Nifty 100 index recorded 4.5, 7.8 and 6.4 per cent respectively. Presently, the Nifty 100 ESG has 88 companies across 16 sectors. Financial services, IT, consumer goods and energy sectors contribute about 74 per cent of the index.

Sectors/Companies that will lose out: Industry experts are of the view that tobacco companies and coal business may find it hard to make the cut in ESG market as they generate huge amount of hazardous waste. Besides these, companies who use lot of water and do not adapt to best practices on its management will find it hard to raise funds in the market. Experts also say that there are internal conflicts in companies at various levels and many investors who are looking at sustainable wealth creation do not want to be associated with such conflicts. For example- Global tobacco industry profits per year is around $35 billion, but also causes death of nearly 6 million people and investors are growing a heart which is sensitive to these realities.

Conclusion: Investors with long term investment horizon can opt for ESG funds. They will be free of tension as their money is invested in ethically and socially responsible companies. In order to attract foreign investors, Indian corporates are being serious to follow the rules of ESG framework. However, at present, ESG market is in nascent stage in India but going forward it will be having a huge potential to grow given its returns.