ESG Investing

Finvest - Finance & Investment Club of IIM Trichy

7 min readApr 17, 2021

Why ESG Investing?

2020, the year of crisis which started with Australian bushfires, an Oil spill in Russia’s Arctic region, North American Wildfires, devastating floods, Spring tornados, Beirut explosion, locust swarms and extended with yearlong COVID-19 pandemic. With all these happenings, it gave a rude awakening to the human about the Planet Earth as a whole. These extreme global climate events have borne aperture between us & our ecosystem, and our decisions in sense of sustainability.

Globalization has changed the world into a complex interconnected place wherein multiple interactions among different stakeholders are causing the rise of many social and environmental challenges. With more than 130 million people worldwide affected with COVID 19 in a timespan of year, lockdowns to contain the spread of the virus have pushed the global economy into recession. Its detection in nearly every country had made this virus one of the destructive economically as similar or more to the Great Depression and the Global financial crisis. The pandemic outbreak with existing problems such as geopolitical risks, fights in global energy markets, etc. have pushed the global markets into turmoil causing huge volatility in equity markets.

As a result of this many investors and policymakers are integrating different unforeseen risks of issues such as climate changes and pandemics into their approach of decision making. This thought process has accelerated responsible investing or sustainable investing. Generally, this is value-based investing, ESG investing (Socially responsible investing), and Impact Investing. Another related branch is thematic ESG investing. Even though this type of investment is growing in recent years, the pandemic accelerated this trend even more.

Equity Market Volatility

In this period of extreme volatility, Morgan Stanley Capital Initiative (MSCI) analysis showed that the ESG funds fared better even during this pandemic-induced downturn in markets.

As per the survey in July 2020 by JP Morgan from various investors in 50 global institutions representing $12.9 trillion AUM on how this pandemic will bring change in investment decisions, 71% of them feel like events such as pandemic which is the low probability/high risk would bring positive change and awareness of high probability /High impact risks of climate change such as an increase in the global

temperature, Floods, Tsunamis, etc. At present, the size of ESG dedicated funds is about 1 trillion which is 2% of the total market. Geographically, North America and Europe constituted almost 90% of the total market in 2018. From this, it has become very evident that ESG investing would be the major parameter for the investors to make a decision.

What is ESG investing?

ESG investing in generic terms refers to an investment approach wherein non-financial parameters of Environment, Social and Governance are considered alongside financial analysis.

In detail, these parameters include

Environment: Generally, the parameters referred are environmental empathy, this particular parameter takes into accounts the impact of companies’ activities on air, water, land, and ecosystems as a whole. Factors included are resource management policies, greenhouse gas emissions such as net carbon emissions of the carbon footprint of the company, waste management policies, and use of green products, infrastructure. The positive outcomes considered the use of environmentally efficient infrastructure and profitability increasing through energy-efficient methods.

Social: Social responsibility primarily includes the corporate activities’ impact on society. This parameter consists of elements related to human capital, other stakeholders of the companies. The factors are the corporate culture of the organization, employee satisfaction, adherence to labor laws, wherein stakeholders are consumers and suppliers’ satisfaction. Investors evaluate the factors such as employee benefits, Payroll, gender diversity (inclusion terms), ethical hiring as well as sourcing through the supply chain, and effective responsiveness to the customers. Usually, this can be seen in employee productivity and morale, fewer attrition rates, and an increase in customer brand loyalty.

Governance: Governance is all about the integrity, diversity of the board of directors, and top-level management. This is one of the parameters which directly impact value creation. The factors included in the analysis for decisions are ethical management (no bribery/corruption), incentives aligned with value creation, and any conflicts of interest. This analysis can be evaluated with value creation for all the stakeholders of the organization.

Performance metrics

Generally, to understand and evaluate the ESG performance of the companies, investors opt for ESG reports and ratings. The ESG reports are made available to investors /the public by the companies themselves under the name sustainability reports. Ratings in comparison to its peers are mostly given by third-party service providers. Some of these ratings and scores are MSCI ESG ratings, Refinitiv ESG scores.

MSCI ESG Ratings:

Morgan Stanley Capital Initiative uses a rules-based methodology to identify industry leaders and laggards.

They rate companies on a ‘AAA to CCC’ scale according to their exposure to ESG risks and how well they manage those risks relative to peers.

MSCI ESG Ratings rates 37 key ESG issues under 10 themes such as Climatic Change, Natural resources, Waste management, Environmental opportunities, Human Capital, Stakeholder opposition Product liability, Stakeholder oppositions, Social opposition, Corporate behavior, and governance.

Refinitiv ESG Scores:

Refinitiv uses the data and analytics to weigh the ESG factors of the company and provides scores for up to 9,000 companies. They provide an ESG combined score which includes both ESG score and ESG controversy score. They offer both percentiles as well as grades ranging from D- to A+.

Apart from the above ratings and reports, the other third-party providers are Bloomberg ESG Data Service, Donjons Sustainability Index, Thomson research ESG research Data are few of them. There are also asset-specific ratings such as GRESB wherein It assesses and benchmarks the Environmental, Social, and Governance (ESG) performance of real assets, providing standardized and validated data to the capital markets.

Types of ESG Investing

For ESG investing, in terms of asset classes, Equity represents approximately half of the total AUM under ESG. recently green bonds are one of the fastest-growing asset classes. In this Fixed incomes markets of ESG, Green bonds were expected to touch $350 billion of issuance in the year 2020 and the suit is expected to follow over the years. Active investments are dominating in ESG markets where passive investment strategies like ESG ETFs are also pacing their focus among the investors. Some of these ESG themed ETFs are iShares ESG MSCI USA ETF shares Global Clean energy, Invesco Solar energy, VanEck Vectors low carbon Energy.

ESG Investing in India

India’s first ESG fund was launched in 2018 and currently accounts for 0.06% of the total AUM in the equity assets class. The current India ESG funds are in the nascent stage which accounts for only Rs 4,500 crores i.e., less than1 % of total mutual funds. These funds are Axis ESG Fund which is launched in February 2020, SBI Magnum Equity ESG fund after reclassification of an equity fund in 2018., Mirae Asset mutual fund launched ESG ETF in October 2020. However, there are no uniform standards for determining the stocks to make ESG cut. So, comparing the returns may not be appropriate.

In the issuance of green bonds which are a kind of ESG dedicated funds, India catered to the 2nd largest market accounting for $10.3 billion transactions. Many banks that issued Green bonds are SBI, Yes Bank, Exim banks, and Axis banks, these banks raised bonds in international markets and used those funds for green projects.

ESG investing before Covid was more concentrated in the countries in North America and Europe, which are considered as developed economies, is now extended to Asian Countries with a wake-up call from Covid while adapting to the new normal. ESG investing may also be a part of the new normal but the most interesting thing to look at it is the way developing economies would like to make this a top priority when the stakes of environmental changes are getting high.