Decoding ESG Investing: The Future Is Green

Last Updated: 1 Aug 2024

In India, the concept of ESG investing is in its early stages. However, the discussion around ESG funds has gained momentum in the recent past. With the onset of the pandemic, there is an increased awareness and responsibility towards socially responsible investing. Let’s decode ESG investing, its evolution and comparison with other indices.

What is ESG Investing?

ESG investing refers to Environmental, Social and Governance investing. Socially conscious investors prefer to evaluate ESG ratings alongside traditional financial metrics. ESG includes factors such as good governance, pollution mitigation, equal Corporate Social Responsibility, etc.

ESG investing funds or ESG funds have been introduced in India by various fund houses. ESG funds are mutual funds that pursue investments in firms that focus on ESG compliance. Over time, there has been excessive importance for ethics and morals for Indians. Investing using a code of conduct appeals to various investors.

ESG funds are widely coveted by High Net-worth Individuals who want to make a difference in society. Millennials and young millionaires are also inclined towards the concept of ESG investing. Lastly, women investors show empathy towards ESG. Considering the demographics of India, ESG funds have a promising opportunity.

Globally, ESG investing inflows were worth $168 billion in 2020 versus $63 billion in 2019. More than 3300 registered funds are investing in ESGs. In the United States, ESG investing accounts for 1.4% of its assets under management. In the Indian context, the combined assets under the management of ESG funds in 2020 was INR 9516 Crores.

Additionally, India’s commitment to reach zero carbon emissions provides an impetus to businesses to turn more eco-conscious. Gradually, the quantum of managers incorporating ESG as a core part of their investment research is increasing. Thus, the significance of ESG investing is established beyond a reasonable doubt.

However, ESG investing is comparatively less developed in emerging markets. Currently, reliable data and ESG ratings are difficult to accumulate. Most ESG funds rely on in-house as well as third-party research to assign scores to companies. Each ESG metric is analyzed thoroughly to short-list a pool of stocks eligible for investment. Analysts and market experts expect efficient access to information once ESG funds become more common.

Evolution of ESG standards

The first move towards ESG investing was made by the Securities and Exchange Board of India in 2012. The market mandated the top 100 listed companies by market capitalization to file a Business Responsibility Report (BRR) periodically. The objective of the report was to ensure adherence to environmental, social and economic guidelines. Further, companies were assigned an ESG score. Later, the BRR requirement was extended to 500 of the top listed companies. Ultimately, by FY19-20, the top 1000 listed companies were required to submit the BRR.

The government has also contributed to the growth of ESG investing by introducing guidelines on Corporate Social Responsibility (CSR) over a decade ago. CSR mandates companies to carry out activities that address the betterment of society. In 2011, the national voluntary guidelines on social, economic and demographics of business were also introduced.

Further, the NIFTY ESG Index is categorically designed to track the performance of companies that are in the NIFTY 100 Index based on their ESG scores. The NIFTY 100 ESG Index has grown at a CAGR of 10 per cent as compared to the 8.7 per cent CAGR of the NIFTY 100. The National Stock Exchange publishes sectoral data on ESG scores.

ESG Indices Versus Equity Indices

In India, ESG was launched in 2018. Since then, the returns of the Top 50 ESG companies is 160 per cent. However, the NIFTY 50 returns during this period were 76 per cent. Since the pandemic, returns from the Top 50 ESG companies are 131 per cent whereas the yield on the NIFTY 50 companies is 117 per cent. Various studies indicate that the Top 50 ESG companies based on market capitalization are consistently outperforming the NIFTY 50 companies.

In FY22, the Top 50 ESG companies have returned 26 per cent viz-a-viz the 21 per cent returns on NIFTY 50. In October 2021 the total market capitalization of ESG companies was estimated at INR 105.22 Lakh Crores. Normally, stronger companies have solid principles around ESG. During the pandemic, ESG compliant companies succeeded in weathering the storm. Not only was the price decline less steep but also the price recovery was faster.

In conclusion, ESG funds’ performance during the selloff triggered by the pandemic and its subsequent recovery has drawn significant assumptions. Nevertheless, ESG investing is still in its embryonic stage and investors need to consider various factors before making an investment decision.

Frequently Asked Questions

What are the demographic advantages of ESG investing?

According to a Knight Frank report, the Ultra High Net-Worth population in India is expected to grow 63 per cent by 2025. Furthermore, the number of billionaires will grow to 162 by 2025. Millennials form more than 45 per cent of India’s working-age population and contribute 70 per cent of overall household incomes. They are more likely to invest in companies that adhere to ESG standards.