ESG: Embracing An Altering Investment Landscape

Amid the spate of corporate governance issues cropping up with rising frequency, Indian markets will see two entities launch the earliest funds based on Environment, Social and Governance (ESG) investing. Chirag Mehta, Senior Fund Manager,  Alternative Investment, Quantum Mutual Fund not only discusses the growing popularity of ESG investing in India in general but also about the firm’s ESG fund explaining what investors should expect out of it in a candid conversation with Himali Patel. 

What is an ESG fund?

Typically, investment choices are made based on expectation of returns and the appetite for risk. However, ESG factors cover a wide spectrum of issues that traditionally are not part of financial analysis, yet may have financial relevance.

ESG investing is an investment discipline that considers environmental, social and corporate governance (ESG), criteria to generate long-term competitive financial returns and positive societal impact. This might include how corporations respond to climate change, how good they are with water management, how effective their health and safety policies are in the protection against accidents, how they manage their supply chains, how they treat their workers and whether they have a corporate culture that builds trust and fosters innovation.

What kind of an investment approach is adopted by this fund?

As long-term investors we fundamentally believe in the importance of ESG analysis as a means to understanding both opportunities and risks. We take a positive approach, looking for businesses that show awareness of material issues and a commitment to sustainability best practice. The investment strategy of the Scheme will be to invest in a basket of stocks after intensive analysis on the environmental, social and governance aspects of the company.

The investment strategy determines sector weightages of a broad well-diversified index for guidance to ensure the portfolio is well diversified. However, the stocks weights reflect companies within each sector that stand high on the ESG parameters. It entails banking on sustainability to drive long-term performance. 

What is the composition of the fund and stock selection?

The fund is market cap agnostic but weighs on liquidity and therefore stocks that trade at least $1 million on an average per day over the last 12 months forms the universe for stock selection. We will study relevant companies on the ESG aspects of the companies and ascertain how prepared these companies are to mitigate these challenges. We will weigh stocks based on ESG scores and check tolerance on sector guardrails to arrive at final weights assigned to each stock in the portfolio. It will eventually result in a well-diversified portfolio across sectors. 

What makes for a stock to enter this fund?

A positive ESG score, which we believe, is a measure of long-term sustainability of the company. To determine, which companies are best equipped to handle, and even potentially help resolve, any of current global challenges; it has become essential to have an effective way to evaluate their ESG practices. The idea is to develop a truly granular understanding of the extent to which, a company will be a good long-term steward of capital and weigh that company accordingly in the portfolio.

What kind of stocks and sectors do you avoid?

With ESG, we take a positive approach, looking for businesses that show awareness of material issues and a commitment to sustainability best practice. In a way this is positive screening for long-term sustainable businesses. However, stocks that tend to have a negative societal impacted like tobacco and liquor, gambling stocks will be avoided. 

Who should invest in this fund? And what should an investor expect when investing in this fund?

Even though it is classified as a thematic fund, for all practical purposes, the quantum ESG fund will be a multi-cap diversified equity portfolio focussing on sustainable businesses that meet the ESG criteria. So, investors looking to invest in companies that are good corporate citizens where sustainability drives long term performance should consider investing in an ESG Fund. Such companies are typically less exposed to tail risks such as environmental accidents or punishment from regulators and excellent ESG standards can function as a guide to a company’s overall quality of management and long-term sustainability. ESG allows you into invest with your values in businesses that are clean, responsible, fair, transparent, ethical,  and having a positive societal impact; yet deliver sustainable profitability in the long run.    

Research has shown that the use of ESG in security selection leads to better-informed investment decisions, and that sustainability funds can perform better than non-sustainable ones, partly because of better risk management over contentious issues. Companies with a lower carbon footprint, for example, would face lower regulatory or societal risk than a polluter, and so its shares should be less volatile over time.