ESG Draws Investors, Green Finance Gathers Steam

In a developing country like India, economic growth, environmental conservation and social responsibility are all interlinked. Last year, our capital city had to shut various services like schools, airlines and distribute masks for an entirely different public health concern i.e. severe air pollution. Climate change is a pressing concern which only seems to be getting worse with the passage of time. Green finance, therefore, takes precedence today to ensure a better tomorrow.

What is green finance?

Green finance is an organised financing strategy designed to create a positive environmental outcome. Green finance covers the following projects:

1. Renewable energy and efficiency
2. Sustainable use of natural resources
3. Pollution prevention and control
4. Conservation of biodiversity
5. Circular economy initiatives

To enable organisations to execute such projects, investors (including retail investors) can park their money with companies that are actively involved in being the harbingers of change to make the world a better place. This strategy is known as Environmental, Social and Governance (ESG) investing. 

How should retail investors decide where to invest?

ESG investing relies heavily upon the ratings provided by independent third-party companies and research organisations as it helps investors decide which companies are making the maximum impact on the three fronts. Here is what investors can delve into for making an informed investment decision:

Environment: How seriously does the company take environmental preservation? Here are some indicators:

• Carbon footprint
• Toxic chemicals (if any) in the manufacturing process
• Efforts to create a sustainable supply chain

Social: Does the company create a positive social impact, not just within but in the surrounding community as well? The indicators are:

• LGBTQ and equality
• Promotion of diversity – even in the senior management
• Inclusion programmes
• Hiring practices and ethics

Governance: Does the senior administration such as the Board drive positive change? Indicators include:

• Executive pay
• Culturally diverse workforce and leadership
• Interaction and response to stakeholder interests and ideas

Stakeholders of a company go beyond just investors and employees. The complete set of stakeholders comprises its workers, customers, communities, shareholders and the environment. ESG investing is based on the correlation between the impacts on the above three fronts with the returns on investment.

ESG Investing in India is gaining traction

A research conducted by Morgan Stanley in 2019 indicated that 85 per cent of all retail investors are leaning towards sustainable investing. This massive uptick can be attributed to various factors.

1. Investors wish to show their support towards the cause by aligning their values with that of the company they are investing in. Retail investors show it by investing in the stocks of those organisations that are known to usher in positive change and create social impacts.
2. The initially fallacious claim of returns on ESG investments being low has been proven false by the data available today. In most cases, it is clearly visible that the returns being generated by ESG investments are either at par or much ahead of traditional investments.
3. Arabesque Partners carried out a research in 2020, which showed that a strong investment performance was rooted in good sustainability practices in over 80 per cent of the cases. In India itself, Nifty 100 ESG has outperformed Nifty50 with quite superior returns over a five-year period when measured in 2020.
4. Sustainable investments add stability to a volatile portfolio, which reduces the risk involved in the investment. A Morningstar report said that the downside risk was significantly reduced in case of an ESG investment as compared to traditional investment.
5. Some experts believe that the price-to-earnings ratio of a company will be influenced by its ESG rating in the future. The growing demand for ESG funds will also reduce the expense burden on the execution of key projects, which was initially considered a restraining factor.

Convenient options for retail investors

Sometimes your belief in the company of choice may not necessarily result in action. To compound the problem, there is still some ambiguity surrounding the quantification of ESG scores of organisations. This leaves investors scanning stocks just to identify the best one to invest in.

Fortunately for retail investors, there are ESG-dedicated mutual funds that not only diversify the portfolio but also reduce the attached risk. Some examples include ICICI Prudential ESG Fund, Aditya Birla Sun Life ESG Fund, Kotak ESG Opportunities Fund, etc.

Each fund deploys a different rationale to create its investment strategy to generate the best possible returns for investors. Overall we can be optimistic about investing in ESG funds as the world has shifted its focus from pure profitability to ‘sustainable profitability’.

The author is the Managing Director at Gautam Solar