Is ESG Investing worth the hype?


Recently, professor Aswath Damodaran – “Dean of Valuation”, gave his remarks on ESG investing as below: 

“I believe that ESG is, at its core, a feel-good scam that is enriching consultants, measurement services and fund managers, while doing close to nothing for the businesses and investors it claims to help, and even less for society.”

And this statement really hit the investor community hard, as ESG investing is gaining popularity globally as well as in India. 

[Source: ICICI Prudential Mutual Fund ppt]

But what really is the buzz around ESG investing? What does it mean and does it even make sense currently? Well these are some of the questions we will try to answer in this article.

So let’s get started! 

What is ESG Investing?

So just to cover in brief, ESG investing stands for investing in companies that are environmentally friendly [E], socially responsible [S], and have good corporate governance [G]. That’s why it is also called sustainable or impact investing.

Therefore non finance parameters are considered for selecting stocks:

E – Duty towards planet

S – Relationship with external and internal stakeholders

G – Functioning of the business and conduct of the management

Companies are analyzed and assigned the ESG score on the basis of below parameters and the one with the highest ESG scores are selected in the portfolio. 

Environment SocialCorporate governance
Efficiently dispose of waste Gender equalityEthical practises 
Address climate change Women empowerment Efficient management 
Prevent pollution Labor welfare & rights Strong internal controls 
Conserve energy Donations to social causes No fraud or illegal activities 
Conserve waterQuality products 

Let’s understand this with an example;

In the Nifty 100 ESG Index, around 80 percent of the index is from stocks in financial services, IT, consumer goods, pharmaceutical and automobiles. Companies that are into oils, chemical and fertilizer manufacturing are therefore ignored. 

Therefore investors feel that they can really make an impact by investing in such funds, and earn returns over and above it. 

And this advantage is clearly exploited by Indian AMC’s who rushed to launch various ESG schemes to lure investors recently. Just to give you a perspective – Over the last 2 years, Rs 12,300 crore was collected by ESG funds in India. A total of 10 funds from various asset management companies (AMCs) are active in this space, with SBI Magnum Equity ESG Fund managing Rs 4,533 crore.

What’s the catch?

But all that glitters is not gold! So it’s time to dig deeper into the situation: 

  • Out of the 10 funds, 7 funds have an expense ratio more than 2%, highest being 2.71%. The funds are simply justifying this high ratio as it’s a niche area. Low returns from such funds does not justify this ratio. 
  • A recent study done by CFA society India revealed that wide variability exists between ESG funds with respect to methodology, scoring criteria and outcomes. 

Example: Number of stocks ranges from 23 and 54, and the weights don’t even match the benchmark universe. Also some funds have exposure to carbon intensive sectors way beyond the limit. 

  • Also a lot of confusion and lack of clarity leads to ambiguous decision making. For eg, ITC has been considered as an anti ESG stock. But just to clear the confusion, ITC is rated AA by MSCI on ESG, the highest among global tobacco players and better than most Indian FMCG companies. This is backed by strong testimonials – ITC has been carbon positive for 15 years, water positive for 18 years and solid waste recycling positive for 13 years. Still it finds no place in most of the ESG funds. 
  • According to a recent CFA Institute global survey of retail and institutional investors, 60% of Indian investors (sample of 200 retail and 75 institutional investors) cited higher risk-adjusted returns as the primary reason for investing in ESG funds, far higher than global sample (29%), and only 30% expressed personal values or making a positive impact as a reason for investing in ESG funds.

As per Mr. Shishir Asthana, one of the research analysts at moneycontrol – Operating from air-conditioned offices using pollutants hydrofluorocarbons to cool their offices and driving a carbon dioxide emitting car to office does not qualify as an environmentally friendly sector. How can the plastic produced in the petrochemical sector be environmentally unfriendly while the same plastic when used to produce consumer electronics or wrap consumer durable products is environmentally friendly?

Well still a lot of thought clearly needs to be given before directly jumping to such styles of investing. 

Do not let your hard earned savings find unproductive use! 

Until next time…….

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