The Future of Responsible Investing in India: ESG as a Critical Tool

Prepare for an exciting journey into the world of Environmental, Social, and Governance (ESG) investing. We will guide you through the intricacies of ESG, its Environmental (E), Social (S), and Governance (G) components, and delve into how to structure your own ESG portfolio.

The Evolution of ESG

ESG investing is currently a trending topic among investors due to its increasing popularity. However, its roots can be traced back to the 1960s and 70s. It originated in South Africa, where global investors began divesting from companies operating there as a form of ethical investing. This initial spark laid the foundation for the ESG (Environmental, Social, and Governance) movement that we witness today. In 2020, ESG investments witnessed a substantial surge, marking a remarkable 15% increase from 2018.

Understanding ESG Factors

ESG investing revolves around selecting companies that prioritize not only profits but also making a positive impact on the world.

The ‘E’ stands for the environment, assessing how a company’s operations impact the planet, including their efforts to combat climate change and manage resources sustainably. An outstanding example is Tesla, which champions electric vehicles to reduce carbon emissions. Environmental considerations pertain to how companies affect the natural world. For instance, when an Indian grocery chain like Big Bazaar committed to reducing food waste and promoting sustainable practices, it makes a significant environmental impact.

The ‘S’ focuses on how companies treat their employees, suppliers, customers, and communities, emphasizing fairness and support. The social aspect of ESG centers on people, encompassing employees, customers, suppliers, and the broader community. Take Infosys, an Indian IT giant, as an example. They are not only technology leaders but are also committed to improving education, skills, and social well-being in India and beyond.

The ‘G’ stands for governance, examining a company’s leadership, pay structure, audits, and shareholder rights, which ultimately influence its long-term performance. Think of the Volkswagen emission scandal as a stark illustration of poor governance in action. Governance encompasses the way a company is managed, including elements like leadership diversity, executive compensation, ethical standards, and shareholder rights. In contrast, consider an Indian company like Infosys, which has consistently earned high governance ratings thanks to its robust board diversity, fair executive compensation policies, and unwavering commitment to ethical business practices.

Analysis Beyond Financials

ESG (Environmental, Social, and Governance) analysis is gaining importance because it provides a framework to assess companies’ performance beyond just financial metrics. ESG rating systems, resembling report cards, are used to evaluate companies’ behavior in terms of sustainability and responsible business practices. Firms like MSCI and Sustainalytics extensively utilize data sources, including public information, company disclosures, and independent research, to assign ESG scores.

These scores provide investors with insights into how well companies in India are addressing environmental concerns, social responsibilities, and governance issues. Notably, companies with higher ESG ratings have shown the potential to outperform their peers in the global market, suggesting that responsible business practices can lead to profitability.

Sustainability reports are similar to corporate diaries where Indian companies voluntarily disclose their ESG efforts. These reports reveal their commitment to sustainable practices, such as reducing carbon emissions or promoting social responsibility.

ESG analysis is particularly relevant in India, where companies not prioritizing these factors may face various risks, including regulatory penalties, employee turnover, or loss of investor trust. Conversely, companies excelling in ESG factors can mitigate these risks and potentially offer more stable returns, aligning with global research that demonstrates better operational performance and lower risk associated with stronger ESG practices. In a rapidly evolving Indian market, ESG analysis becomes a critical tool for investors looking to make responsible, sustainable, and potentially profitable investments.

Creating an ESG Portfolio

Building an ESG portfolio in India is a personalized journey tailored to your financial goals and values. If you are passionate about combating climate change, focus on companies with strong environmental practices or invest in clean energy funds. For those prioritizing social justice, seek out firms with robust diversity and fair labor practices records. In India, there are several ESG-themed investment options to choose from. Diversification is crucial, not only across asset classes and sectors but also by balancing various ESG factors. This could mean investing in environmentally responsible companies, socially conscious enterprises, and businesses with strong governance practices. Regularly monitor your ESG investments, paying attention to ESG ratings and sustainability reports, as performance isn’t solely about financial returns but also about the positive impact on society.

Following are the Equity: Thematic-ESG Funds and their performance as of October 26, 2023.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to change. Please consult an expert before making related decisions.