Invest Guide April 2023

Environmental, Social, and Governance (ESG) investing has surged in popularity over the last few years, and an increasing number of investors are starting to either invest in ESG funds or take ESG considerations into account when making investment decisions. However, there are lots of stumbling blocks which is inevitable in a world expanding at such a breakneck pace.

There is a lack of trustworthy information about ESG investing, and problems with its performance have not been adequately explored. There is a need for more research into ESG investing now that India is beginning to embrace ESG.

Governance, Social, And Environmental (ESG)

A seasoned investor knows that an organization's returns and financial performance can be affected by variables other than monetary ones. Financial analysts are knowledgeable of the dangers attached to non-financial variables, although it can be difficult to quantify them.

Social impact investing takes into account both financial and social returns, while traditional financial investing focuses solely on maximizing shareholder value. ESG investing falls halfway in the centre and refers to the process by which investors take into account environmental, social, and governance issues in order to optimize the long-term value of their assets. ESG investing is a useful instrument for risk management and assists investors in aligning their investments with their personal beliefs and ethical standards. All three types of investing—Social Impact Investing, Impact Investing, and ESG Investment—use ESG measures and methodology, but they vary in how much attention they pay to the kinds of returns they seek. ESG investing, in contrast to the former two, prioritizes financial returns that generate long-term value while also considering environmental and social factors. In some ways, the first two have a philanthropic bent, whereas ESG investment has a purely financial bent.

Trends -

The popularity of ESG investment has increased globally. According to data, there is a 53% increase in the value of sustainable mutual funds and ESG-focused exchange-traded funds, bringing the total to $2.7 trillion. More than 18% more money flowed into ESG-focused funds in 2021 with a record $649 billion coming in November alone.

According to the statistics, the expected net flow in sustainable funds worldwide is currently about $600 billion, demonstrating a constant increase from the prior values of $200 billion and $400 billion in 2019 and 2020, respectively. It is expected that overall net assets in sustainable funds would reach roughly $2.7 trillion by year's end, a significant increase from the $1.0 trillion in 2019 and the $1.8 trillion in 2020.

By taking a bird's eye view of the industry, India's tale does not stand out from the pack in any way. By March 2022, India's ESG funds had increased to Rs. 12,448 crore, up more than 13% from 2021. The fiscal year 2021 was a standout year for ESG funds, which saw growth of more than 200% over the previous year due to the launch of multiple funds. In India, investors prefer to focus on ESG funds more during New Fund Offerings (NFOs), and the subsequent loss of traction is apparent. ESG funds saw a net outflow of INR 315 crores compared to an influx of INR 4,844 Crores in FY21. Indian investors are becoming more interested in ESG funds, yet investors have not yet warmed up to them the way the rest of the world has. The majority of inflows took place during new fund offers.

Driving Factors -

According to a research, the top three worldwide drivers of ESG are social/moral considerations (77%), risk reduction (14%), and the pursuit of alpha (6%). Other factors, such as increased long-term profits, stronger brand awareness, lower investment risk, fewer legal obligations, fewer demands from external stakeholders, etc., are also driving investors toward ESG.

In India, the situation is similar, and the Securities and Exchange Board of India (SEBI) is concentrating on harmonizing the legal requirements. The Business Responsibility and Sustainability Report (BRSR) was introduced by the SEBI as a new framework for environmental, social, and governance reporting. The top 1,000 publicly traded firms are expected to file BRSRs in which they evaluate their significant ESG risks and opportunities, offer plans for reducing or adjusting to those risks, and detail the financial ramifications of those risks.

BRSR is a framework that has been established as a standard with the goal of addressing the changing reporting environment for sustainability around the globe. Corporates are required to conduct business ethically and uphold reporting transparency as the reporting environment in India rapidly changes to conform to international norms and rules. In India, BRSR will centralize information about sustainability reporting. The SEBI has decided to make BRSR-based reporting optional for the fiscal year 2021-22, but it would become mandatory beginning in the fiscal year 2022-23.

The BRSR questionnaire is divided into three sections:

• general disclosures
• disclosures on management and processes
• principal-specific performance disclosure

General disclosures under BRSR cover information about the listed entity, its products and services, its commercial activity, operations, holdings, subsidiaries and associate companies (including joint ventures), corporate social responsibility, transparency, and disclosure compliances.

Management and process disclosures address issues of policy, leadership, and oversight in the second segment.

The final section, Principle-wise performance disclosures, divides the remaining KPIs into two subcategories: critical indicators and leadership indicators.

Data on training programs, environmental statistics on energy, emissions, trash, and water, social effect made by the organization, and other types of data are examples of essential indicators that must be collected. Companies may choose to disclose leadership indicators for improved accountability and responsibility. Information on life cycle assessments, conflict management policies, supplier chain disclosures, etc. are all included here. In order to increase thoroughness and standardize the reporting process, it is possible that the questions in the leadership area will be moved to the essential category.

Performance Of ESG Funds In India -

Due to the fact that several ESG funds were just created this past year, it can be difficult to analyse their success in India. Analysing the NIFTY100 ESG, a benchmark index, is one method of estimating performance from above. Based on a company's Environment, Social & Governance (ESG) score inside the NIFTY100 Index, the NIFTY100 ESG tracks its performance.

The free-float market capitalisation of each index constituent and its modified ESG risk score, which is changed depending on the ESG score assigned to the firm, are used to calculate each constituent's weight. The top five index businesses and sectors are listed in the following table.

The majority of funds consist of cash, shares, debt, money market instruments, and ESG stocks. ESG equities are the shares of businesses with excellent corporate governance standards, a main emphasis on environmental issues, and a focus on employee concerns and broader social issues. Based on ESG criteria, the ratings are offered by ESG rating companies including MSCI, Morningstar, and Bloomberg. ESG equities can be recognised by higher-rated companies. Although there isn't a set procedure per se, each rating provider has its own criteria, which the authorities find contentious. The SEBI intends to standardize this through a legislative framework that mandates accreditation for all rating agencies. Only research analysts and credit rating firms will be permitted to register with the SEBI as ESG rating providers, according to additional information provided by the SEBI. ESG ratings are ultimately assigned by these rating agencies based on ESG scores. The ESG ratings offered by MSCI are on a seven-point scale: AAA, AA, A, BBB, BB, B, and CCC. The top two grades are regarded as leaders, the next three as average, and the final two as laggards.

Environmental, social, and governance aspects are the three areas under which the variables used to construct ESG ratings are divided. Climate change vulnerability, water sourcing, biodiversity, land usage, sourcing of raw materials, and other environmental aspects are examples of environmental factors. Social considerations include worker training, supply chain labor standards, chemical safety, consumer financial protection, privacy and data security, among other things. They also include health and safety procedures and practices. Governance variables, on the other hand, include things like the diversity and independence of the board's makeup, as well as executive compensation, ownership, and accounting procedures.

The top four ESG funds by assets under management (AUM) are SBI Magnum Equity ESG Fund (Rs. 4,456 crore), Axis ESG Equity Fund (Rs. 1,534 crore), ICICI Prudential ESG Fund (Rs. 1,231 crore) and Kotak ESG Opportunities Fund (Rs. 1,126 crore). The SBI Magnum Equity Fund invests 80% of its money in ESG stocks and 20% of its money in stocks, bonds, and money market instruments. Kotak ESG Fund uses an ESG rating system along with a business, management, and value model to construct a portfolio. Similar strategies are utilized by other funds as well. These investment vehicles all aim to find the finest equities that also meet environmental, social, and governance standards.

Since the vast majority of these funds have only recently debuted, a 1-year performance comparison to the NIFTY 50 index appears reasonable. Based on the data, only SBI Magnum was able to generate alpha and outperform the NSE NIFTY50 index over a 12-month period. Looking into SBI Magnum's 5-year record, however, it becomes evident that it fared poorly (11.87% returns) compared to the NSE NIFTY 50 index (14.15%).

In general, ESG funds and the NIFTY50 index have a lot in common. With an intersection portfolio of 71.14 percent, SBI Magnum has the largest degree of overlap with the NIFTY50, followed by the Kotak ESG fund at 66.44 percent. At 46.64%, 17 Axis and ICICI are last.

Due to the dynamic and ongoing nature of the overlap between fund portfolios, the above table only reflects the situation as of June 2022.

Challenges -

History: Three of the top four ESG funds in India were only introduced in the last 2-3 years, making the phenomena relatively new. There is not yet sufficient evidence from the past to draw any firm conclusions. This difficulty may become less of an issue as time goes on, and it may even motivate savvy investors if the funds do well.

India's ESG reporting is not of the highest quality, hence its data is not the most reliable. Under the new BRSR ESG reporting framework, the SEBI is attempting to standardize it and has increased the ESG reporting requirements for the top 1,000 listed businesses. To get higher ESG ratings, corporations could, however, "greenwash" the data in an effort to give the impression that they are environmentally sensitive, fooling investors into believing they are. If this problem can be overcome, one of the main obstacles standing in the way of ESG investing will be removed.

Market scenario: Although the SEBI requires that 80% of the companies in any ESG fund be ESG compliant, or more precisely match the schemes' objectives, the market is not reflecting this need. There are times when a judicious portfolio cannot be constructed by a fund manager. Many Indian businesses, including ITC, Reliance, and others, include both ESG and Non ESG components. There aren't many green and sustainable businesses in the Indian ESG market. It consists primarily of companies who are now performing well and moving toward sustainability.

Conclusion -

ESG funds are a relatively new concept in India; nevertheless, while they are being welcomed with open arms around the globe, they have not yet reached that level of adoption in India. From data dependability and reporting laws to market conditions, India faces its own set of challenges. This is why ESG funds have underperformed the market. As new funds are offered, many investors sign up, only to withdraw their subscriptions later due to subpar performance. There is a lot of overlap with straightforward index funds, so it stands to reason that if India's economy develops and its infrastructure for data reporting gets stronger, ESG investing will become a more appealing choice than it is right now, which doesn't appear to be the case.