By Harshvardhan Roongta
The Covid-19 pandemic has laid bare many gaps in our ecosystem and underscored the need to evaluate the impact of our actions and choices on our society and the planet. Inarguably, the world is becoming increasingly interconnected and complex. Multiple interactions among governments, businesses and people are giving rise to environmental and social challenges ranging from climate crisis to poverty and unemployment.
These require urgent attention. They require a concerted and collective response by all stakeholders to better integrate environmental and social parameters in all aspects of decision making. The financial services industry can play an integral role in mobilising capital to address Environmental, Social and Governance (ESG) risks and to leverage the emerging opportunities through ESG investing.
ESG investing is fast gaining currency in the financial world. This is evident from the swelling ranks of people who are now beginning to apply ESG filters to their investment decision making. The total assets under management currently under ESG across Europe, United States, Canada, Australia, New Zealand and Japan, as per Global SRI, stands at $ 30 trillion.
So, what is ESG Investing?
ESG investing refers to an investment approach that is tethered to a philosophy of ‘sustainable investing’. This is basically a term that encompasses all investments that seek to generate positive returns while delivering a long-term positive impact on the society and the environment. These investments weave together business performance, society, and the environment in an attempt to generate positive impact for all.
ESG investing is a combination of traditional approach to investing and sustainable investing. An ESG investor first shortlists companies based on traditional financial metrics and future growth expectations. Once shortlisted, these companies are filtered further based on the environmental, societal, and governance attributes that they possess or would have demonstrated.
In effect, ESG investors actively seek out companies that have demonstrated a commitment to ESG factors and invest in such names for long term sustainable wealth creation.
Applying ESG lens to investments
- Environment: A company’s activities can have a negative or a positive impact on air, land, water, ecosystems, and human health. Factors that investors can evaluate to assess the impact of the company’s activities on the environment include policies related to resource management and pollution, focus on reducing emissions and climate impact, usage of green products, technologies and infrastructure, water and waste disposal policies, etc. The environmental outcomes that could be considered as positive could include expanding the use of environmentally efficient infrastructure, improving profitability through energy efficiencies, etc.
- Social: This primarily refers to the impact that a company’s activities can have on society. The social component consists of various elements related to human capital like employee satisfaction, company culture, and stakeholder, i.e., customer, consumer, and supplier satisfaction. Factors that investors can evaluate include employee treatment, pay, benefits, and perks, diversity and inclusion in hiring, ethical supply chain sourcing, effective customer service responsiveness, etc. Socially positive outcomes will be evident in increasing employee morale, improving productivity, reduced turnover and absenteeism, and improving brand loyalty.
- Corporate Governance: This component relates to the way the company is run by its board of directors and the senior management. Investors can analyse how the business is managed, whether corporate incentives are well aligned with shareholder value and business success, are any conflicts of interest, etc. Positive outcomes translate to value creation for all stakeholders.
ESG: Catering to multiple needs
ESG investing can cater to multiple needs of an investor. It can not only help uncover attractive long-term investment opportunities but can also be instrumental in reducing investment risk. ESG factors, if not addressed proactively, can pose serious risks to a company’s operations and profits.
Companies that recognise this threat and incorporate ESG risk management can prove to be better long-term custodians of investor capital, provide enhanced downside protection, and generate better long-term risk adjusted returns. Further, investors are becoming increasingly conscious of their ESG impact.
Many are looking beyond financial outcomes when it comes to investment decision making. They are looking at the impact of their investments on ESG and the role that their assets can play in promoting ESG issues like climate impact.
While ESG investing has become quite the buzz globally, it is only now gaining traction in India. However, investors are beginning to recognise the importance of weighing both financial and non-financial metrics while making investment decisions. The key is to understand the factors that contribute to the value of ESG investing and making investment decisions that are well-aligned with the overall asset allocation strategy.
(Harshvardhan Roongta, CFP, is the Co-founder Roongta Securities. Views are his own)