Coronavirus gripping the world has re-emphasized the importance of sustainability of resources in our lives. As the world fights back against this devastating virus, questions regarding climate change and degradation of natural resources are gaining momentum and forcing us to think about whether advancement at the cost of survival is endurable. In the past, we have had episodes of corporate greed wreak havoc and reconfigure the distribution of wealth into a more concentrated pattern through unethical and, in many cases, illegal means. Episodes such as these were perpetrated by the perverted use of sharp intellect and, in turn, brought corporate governance to the mainstream for investors. However, from where we stand today, governance alone won’t cut it in the near future. Triple bottom line, which was once a fancy concept, is no longer a luxury. Research proves that companies following it are rewarded more handsomely when pitted against their peers who continue to focus only on profits as per traditional norms.
Over the past few years, the world of investing has witnessed a paradigm shift in the values driving investment. The shift in values is evident from the investor sentiment, which sees a surge in ESG investing, socially responsible investing (SRI), and impact investing. In ESG investing, investors focus on the correlation of the three factors (Environmental, Social, Governance) with the company’s performance and make decisions based on how these factors will impact an investor’s returns. However, in SRI, investors map their portfolio to their beliefs and values using positive or negative screens and include or exclude companies based on it. Impact investing aims to maximize societal reach in a quantified manner.
As per EPFR’s recent report, SRI and ESG investments recorded inflows of $168.74 billion in 2020, up from $63.34 billion in 2019. According to a Morgan Stanley survey conducted in 2019, 85% of retail investors are interested in sustainable investing. The surge can be attributed to several factors, amongst them awareness about pressing issues and an opportunity to express by aligning one’s values to profitable investment are front runners. The initial fallacious premise of inferior returns has been rendered baseless by data that indicates that sustainable investments can generate at par and, in many cases, superior returns to traditional investment styles. As per research conducted by Arabesque Partners in 2020, 80% of the studies reviewed indicated a positive influence on investment performance rooted in sustainability practices. Back home in India, the NIFTY 100 ESG Index has outperformed NIFTY 50 by delivering superior 5-year returns in 2020. ESG ratings having a positive impact on a company’s performance can be traced to mitigating financial risk via adoption of sustainable practices. Sustainable investments also tend to add a layer of stability which reduces the volatility of the investment. According to a Morningstar report, sustainable investments offer lower downside risk when compared to traditional investments. Some experts also believe that ESG ratings may affect the P/E of companies in the near future. An increase in demand for ESG funds will normalize the expense ratio, which was initially considered a restraining factor.
The challenges of SRI and ESG investing when it comes to stocks include time involved in researching whether the companies fit your criteria as promises made may not necessarily convert into actions on the part of the company. The ambiguity in quantifying ESG scores adds to the problem. Thus, mutual funds or ETFs are more convenient options for retail investors who will still be required to scan the portfolio to ensure that the companies mirror their personal values and beliefs in terms of addressing a particular sustainability issue. In India, several funds like Aditya Birla Sun Life ESG Fund, ICICI Prudential ESG Fund, Kotak ESG Opportunities Fund, etc., exist for retail investors to choose from. Each fund has its investing style. For example, while Kotak ESG Opportunities Fund focusses on the ESG principles followed by a company known through its disclosures and ESG score calculated by its proprietary Business, Management & Valuation (BMV) approach, the Mirae Asset ESG Sector Leaders ETF is managed passively by mimicking the weights of the stock in Nifty 100 ESG Sector Leaders Index. On the other hand, Quantum India ESG Equity Fund focuses on a long-term strategy using its proprietary framework for evaluating companies based on ground research.
In India, traditionally, investments in equity markets and mutual funds are viewed from the lens of gambling. It must be noted that though the mental accounting bias persists, the scenario is changing rapidly. The real question is whether sustainable investing will be viewed differently from traditional investing in the Indian context and thereby draw more investors looking to contribute positively to society and earn handsome returns while they do so, or will sustainable investing be engulfed under the ambit of traditional investing perception? Either way, we can be optimistic that following the world pattern, there will be a substantial adjustment in the composition of investors for traditional and sustainable investing.
Neelam Rani is an Associate Professor (Finance) at IIM Shillong and Ishan Pandey is PGP 19 participant and an office bearer at Niveshak – The Finance & Investment Club at IIM Shillong.