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The Evolving Paradigm of ESG Investment in India
Environmental (E), Social (S), and Governance (G) – ESG – considerations have increasingly become central to sustainable investing worldwide. Although these elements are non-financial, they hold long-term importance to a company's finances. This can include organisations' responses to climatic challenges, resource management, employee-centric internal policies, and fostering an innovative corporate culture, amongst other considerations.
Investor demand for ESG investment has grown immensely, creating a need for ESG-aligned strategies. This article explores the critical questions concerning ESG investment in India, particularly in light of existing regulations, disclosures, and equity schemes.
The ESG concept emerged from a 2005 study titled "Who cares Wins." Since then, global assets under ESG consideration have skyrocketed to $35 trillion, according to Bloomberg Intelligence. The COVID-19 pandemic and the goal of achieving zero carbon emissions by 2050 have further fuelled ESG investing. In contrast, India's ESG fund AUM quadrupled from 2019 to Rs. 12,320 crores as of November 2021. However, this only constitutes 0.3% of the industry's entire AUM of 38 lakh crores.
Indian ESG Landscape: A Comparative Perspective
As of 2021, India has ten domestic ESG funds, with eight launching in the past year in response to the pandemic, indicating a trend towards profitability without sacrificing sustainable growth. However, this pales in comparison to the over 3000 global ESG schemes.
According to the UN report on sustainability for 2021, India ranks 120th out of 165 countries in terms of sustainability. Moreover, India lacks a lengthy history of ESG fund declarations and regulations. Indian AMCs use their expertise to classify funds as ESG-compliant, relying on data and ESG scores published by external rating agencies. However, due to the ambiguity of ESG parameters, scoring is fraught with numerous challenges and uncertainties.
The Complexity of ESG Scoring
Scoring is complicated by the diverse nature of businesses and the industries they operate in. For example, IT companies may have a low ESG risk score due to their low carbon emissions, making them environmentally friendly. However, their data privacy practices can lead to social non-compliance.
The sectoral examination of the portfolio of ESG funds in India's domestic MF schemes reveals that 116 equities form the ESG Universe in Indian MFs. However, due to the non-uniformity and non-standardisation of ESG classifications, it appears there is a much larger pool of potential investments.
Overlapping of ESG and Flexi Cap Funds
In May 2021, Value Research conducted a study titled "ESG versus Flexi caps." They found a degree of overlap between the stock portfolios of ESG funds and Flexi cap funds. The overlap of stocks ranged from 6 to 27, and the net assets of the Flexi cap fund that resulted from the overlap ranged from 18% to a whopping 70%. Infosys Ltd, HDFC Bank Ltd, TCS, HDFC, and Kotak Mahindra Bank Ltd were the top five overlapping stocks of ESG funds among 50+ Flexi cap funds.
Evaluating the Performance of ESG Category
While the primary aim of investments is profit, it has become crucial to evaluate the ESG category's success. When we compare the average returns of ESG funds on a one-year, three-year, and since inception basis, they have been comparable to or less than the category averages of Large & Mid Cap and Flexi cap categories. The risk-reward ratio is also slightly lower for ESG investments.
Conclusion: The Future of ESG Investing in India
ESG as a concept emphasises investing in stocks or funds that genuinely represent sustainable growth and can positively impact the long-term profitability of companies. However, adherence to disclosures, guidelines, and regulations is paramount.
In India, voluntary disclosures by firms seem to carry more weight than mandatory ones. The introduction of the BRSR legislation is a positive step, but SEBI will need to mandate and define what constitutes an ESG fund in the near future.
Covid-19 has been a turning point for ESG funds in India, but the country has a long way to go in terms of mature reporting, analysing, and demanding accountability for sustainable business practice. Until then, it is preferable to monitor the trend and continue investing in diversified funds that currently provide exposure to ESG stocks and offer a superior risk-reward ratio.
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