The acronym ESG dates back to 2004, when a report commissioned by the UN called for “better inclusion of environmental, social and corporate governance (ESG) factors in investment decisions”. In the wake of corporate scandals such as Enron and WorldCom, and the Exxon Valdez oil spill, financial institutions eagerly signed on to the “global compact”.
The movement to reform capitalism has seen a wave of converts in recent years. The Business Roundtable, which represents CEOs of the country’s largest companies — from Comcast to Coca-Cola, Walmart to Wells Fargo — issued its Statement on the Purpose of a Corporation in the summer of 2019. In so doing, it joined a broad coalition — from U2’s Bono to BlackRock CEO Larry Fink — who want capitalism to serve workers, customers, and the environment in addition to shareholders. Investors with $100 trillion of assets under management have signed on to the United Nations Principles for Responsible Investment, which advocates for a greater focus on environmental, social, and governance (ESG) issues in investing.
As investors who helped launch Bain Capital’s social impact fund, we applaud the commitment to reorienting business toward the greater good. But we should approach the latest commitments to ESG with skepticism.
ESG Investment in India
Globally, ESG investments continue to rise. ESG assets are on track to exceed USD 53 trillion by 2025 and represent more than a third of the USD 140.5 trillion in projected total assets under management (AuM), according to Bloomberg Intelligence. Increased investor demand, emerging regulatory requirements, and the launch of several ESG funds have fueled a surge in ESG-focused asset allocations.
The Indian investment management industry has also seen the launch of nine ESG-focused funds in the last few years. A recent study done by CFA Society India and CFA Institute on Indian ESG funds suggest that the ESG integration practices are understandably in relative infancy, and wide variability exists across ESG funds w.r.t their investment approaches, ESG scoring methodology and outcomes.
It has been estimated that inflows in ESG mutual fund schemes in India have increased by 76 percent in 2021, increasing from Rs 2,094 crore to Rs 3,686 crore in the time period 2019-20. In addition to this, in 2020, India’s large asset management companies (AMCs) have launched schemes that have a clear focus on ESG aspects. In the stock indices too, the sustainability themed index NIFTY ESG 100 has outperformed the NIFTY 100 across between 2020 and 2021. Further, anticipating stable, long-term risk-adjusted returns, pension funds too have started integrating ESG factors.
Contributions to better performance of ESG portfolios vis-a-vis conventional ones
Positive performance is attributed to accounting for ESG risks, thereby emphasising on risk-adjusted returns. In case of funds, value creation is obtained through cost reductions from effective resource utilisation, increase in social credibility and reputation, developing stronger community relations, increased governance, and undertaking long-term investment decisions to minimise the risk of stranded assets. For companies, long-term value creation is achieved through investing in sustainability strategies, and communicated to investors through effective disclosures. This increases accountability to both its internal and external stakeholders.
The changing paradigm of institutional investments is evident through increased ESG integration in India. Addressing the barriers will enable to expand ESG integration in fixed income and structured finance spaces. Nevertheless, an overarching regulatory framework needs to be established to fully reap market benefits.