ESG – The Next Big Investment Theme?

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  • 09 May 2023

ESG investing is quite a rage these days. Not only investors, but also businesses and even lenders have settled in the Environmental, Social, and Governance (ESG) space. Will they prove to be a game changer in the future of investing? Let us dig in deeper.

The age of investors is changing. From profits and dividends only, new-age investors are now seeking the companies that care about people, planet & profits. ESG investing is based upon the assumption that the financial performance of organizations is affected by environmental and social factors.

Some ESG questions influencing us as investors include: Is the company focused on achieving net-zero emissions? Have they covered the issues affecting employees, customers, suppliers and the community? How are audits practices and business ethics?

India has witnessed many stranded projects due to ESG problems, like Satyam saga, Coca Cola Plachimada plant, Vedanta’s mining concerns in Odisha and Tamil Nadu, etc. These ESG related events show that profitability and survival depend on how ESG risks and stakeholders’ interests are managed.

Besides, in the last few years, climate change has threatened the agricultural productivity, health and well-being of the humans and biodiversity. Therefore, it is important that industries, government, and individuals come together and make a conscious effort. In an emerging country like India, this theme will lead more companies to be ESG-compliant, leading to sustainable growth for future generations.

The principles of ESG investing are not new. Hundreds of years ago too, religious and ethical beliefs influenced investment decisions. For e.g., Muslims complying with Sharia law. In the present times, the pandemic acted as a strong trigger to reshape the businesses. It has forced the world to hit the reset button and think.

Hence, in late 2020, SEBI introduced new norms for ESG disclosures by the top 1,000 listed entities by market capitalization. Actually, ESG focus dates back to 2012, when SEBI mandated the top 100 listed firms to have a business responsibility report. In the post-Covid world, ESG became a big fund puller and became big theme globally. ESG-focussed funds in India too witnessed exponential growth, with the AUMs increasing from US$283.5 million in March-19 to US$1.5 billion in March-22. Until October 2020, there were only three ESG funds in India. By now, all the big fund houses have their dedicated ESG funds. The trend will continue.

Amongst various initiatives, investment in areas such as renewable energy, electric vehicles, green hydrogen, battery storage, and carbon capture, promise to be the biggest opportunities for ESG.

Necessary but Complicated

ESG is all about investing ethically. But what really accounts for ESG compliance can be highly subjective and one may feel confused about what qualifies and what doesn't.

For example, big tech companies announced their goals of becoming carbon-neutral in the coming decades. While this rates them high on environmental factors, their policies related to data privacy remain a concern on the social factors. So, finding all the three components of ESG in a single company could be difficult. Further, not all ESG parameters have clear-cut boundaries and not all 'green' investments are actually green. Johnson & Johnson is another such example - one of the holdings of funds claiming to invest ethically. The cover of being socially fair was taken off when its baby powder was found to contain asbestos - a cancer-causing product.

So, blindly buying stocks based on ESG ratings could be a huge mistake. One that could even lead you to the IL&FS or Satyam of tomorrow.

The Investment Case

While ESG-compliant companies are screened based on how good or bad the business is for the society. For an ESG-conscious investor, this means that until the above issues are taken care of, investing for a 'higher cause' may not be entirely rooted in reality.

So, take the ESG ratings for stocks with a pinch of salt.

References: Investopedia

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Economic Times

Medium

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