Why you should invest in ESG?

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 6^th 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.

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

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: 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
• Motivated employees

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.

Green Portfolio’s approach to ESG:

At Green Portfolio, we believe ESG will become mainstream soon. The world needs to become more sustainable and in our view we want to support that by investing in companies that invest in making our world a better place for everyone. We will not invest in companies that pollute the environment or treat employees and shareholders unfairly. We will stay away from companies that promote inequality or ill-health. For us both quantitative factors and qualitative factors are equally important and we don’t want to compromise on either.

At Green Portfolio we have decided to focus on Mid/Small cap ESG compliant companies across multiple sectors, which we believe is a differentiator because majority of the ESG funds focus on large cap companies with higher concentration towards banking and IT sectors.

We believe that investing early in Mid/Small cap companies allows us to benefit from the large pool of capital that will find its way into emerging good quality high ESG rated small/mid cap stocks as these companies grow in size and scale. We believe these companies will scale faster, command premium valuation and become potential multi-baggers in the long term.