ESG Investing and Its Key Benefits

You would agree that we are part of a larger ecosystem, where sensible handling of the environment and social issues, are essential in the path to progress and sustainable living. Governance also plays a key role, without which, everything can fall apart and progress in its true sense may never see the light of the day.

Thankfully, the private sector now is recognising the importance of this larger goal. In addition to, taking Corporate Social Responsibility (CSR) projects, many of them are even making conscious investment choices, turning sensitive to Environment, Social and Governance (ESG), which are crucial subject matters.

"Globally, institutional investors such as pension funds give a lot of importance to ESG parameters for making investments. Awareness of governance and environmental issues is picking up in India, too," says Jimmy Patel, Managing Director and Chief Executive Officer of Quantum Mutual Fund.

The ESG theme is growing big globally and India is fast catching up and a few mutual fund houses are introducing their versions of ESG Funds.

Quantum Mutual Fund, which pledges to serve investors with the highest standards of ethics and transparency, has come up with its offering: Quantum India ESG Equity Fund, an open-ended equity thematic scheme.

So, what is ESG?

Explaining the concept of ESG investing

ESG refers to Environment, Social and Governance. These are vital facets of the larger ecosystem we live in.

Being ethical and sensitive towards these issues are important for fund managers, and they need to invest sensibly in the long-term interest of investors.

At the broader level, asset managers have a fiduciary responsibility to play while they serve the interest of investors and the community or society at large. Hence, their investment decisions need to be made paying heed to matters such as the following amongst many others:

Industrial waste management - Whether the corporate is taking due care while disposing of the waste, reducing carbon emissions etc. so as to not harm the environment.

Energy conservation - The contribution of the corporate towards conserving energy vide use of natural methods viz. solar power, natural lighting, energy-saver lamps and so on.

Land clearance - Is the land clearance for projects done ethically, legally, and with due care for environmental issues.

Wages and Human Resources policies - Whether wages, compensation, and the human resource policies, in general, are the best in the industry for the fair, ethical and non-exploitative and non-discriminatory work environment to prevail. Also, is the corporate taking care regarding the health and safety of the employees?

Social issues - Is the corporate making a positive impact on the lives of people and the community at large? Companies engaged in the business of tobacco, alcohol, controversial weapons and gambling operations should be excluded from the purview.

Governance - A check on the background of the founders, their values and vision as they run the organisation, the adeptness of the board, the independence of the board, and their freedom to speak up on important issues, amongst many other points.

Thus, it is not purely a top-down approach (as in case of other thematic funds) but also encompasses a bottom-up approach to investing.

When a mutual fund scheme follows this theme, it sets the performance matrix accordingly whereby it can measure the sustainability or the future preparedness of the companies under consideration recognising their role in the larger community, the risk involved, the competitive advantage, while ultimately aiming to accomplish the stated investment objective of long-term capital appreciation.

Here are a few key benefits of ESG investing:

  1. Diversification- Unlike other sector or thematic funds, good ESG Funds offer fair diversification with of course Environment, Social and Governance aspects being the focus while constructing the portfolio of mainly equity and equity related instruments of companies. The stock picking universe is not limited to a sector but the diverse universe of stocks that satisfy the ESG criteria, which could be from hundreds of companies.

  2. Better investment allocation - For an investor, ESG investing also offers an avenue for better investment allocation. Therefore, in addition to exposure to diversified equity funds, you may also consider investing in an ESG Fund to enhance your investment returns.

  3. Competitive advantage for potential returns - If the portfolio of an ESG fund is well-constructed, comprising of companies offering a competitive advantage in the long-term, it can result in outperformance compared to its benchmark index.

Thus, if you as an investor are willing to embrace the trend of socially responsible investing and use the investment process that reflects values and beliefs, it can reap the sweet fruit of worthy returns in the long run in the form of better risk-adjusted returns. Note that ESG compliance by companies is their only way to ensure prosperity and perpetuity, which in turn can prove rewarding for their investors.

What is the risk element in ESG investing?

Being thematic in nature, there is a high risk involved in ESG investing.

(Indicative and for illustration purpose only)

The fortune of thematic funds is closely linked to the fortune of the underlying theme. Thus, if the portfolio is highly concentrated, it makes them a very high risk-high return investment proposition vis-a-vis diversified equity funds that invest and hold the mandate to invest across sectors and various market capitalizations (whereby the risk is reduced).

Similarly, many ESG funds even though being thematic in nature, follow a well-diversified approach to sector and stock selection, and therefore might not be as risky as one would perceive any other sector/thematic.

Hence, investors have to look at the portfolio construction approach more deeply to determine the level of risk.

Note that given the positive characteristics of ESG investing, it can outweigh the risks in the long-term and prove to be a rewarding experience.

The future of ESG investing:

The awareness about ESG issues has grown considerably. An increasing number of investors are taking into account 'sustainability' as an important aspect of their portfolio while they aspire to be socially responsible investors. Even Foreign Institutional Investors (FIIs) have now become increasingly conscious about where they invest. Besides, more and more companies are making a conscious effort and improving their ESG practices.

How has the Nifty 100 ESG index fared?

Note: Nifty 100 ESG index has a base date of April 1, 2011, and a base value of 1000
(Source: NSE Indexogram Factsheet as on May 31, 2019)

The current climate is turning the spotlight on to the ESG theme. This is not just the topic of discussion in the developed economies in Europe and the US but also perceived to be significant in Asia and emerging market economies.

Also, in recent years, the availability of alternative ESG information and tools has vastly increased so as to assist in worthy decision making that can, in turn, go on to build long-term wealth for investors.

Why should retail investors consider investing in ESG?

Quantum India ESG Equity Fund

Quantum India ESG Equity Fund is an open-ended equity scheme investing in companies following Environment, Social and Governance (ESG) theme.

Investment Objective:

The Investment Objective of the scheme is to achieve long-term capital appreciation by investing in share of companies that meet Quantum's Environment, Social and Governance (ESG) criteria.

How will Quantum India ESG Equity Fund allocate its assets?

Under normal circumstances Quantum India ESG Equity Fund will allocate its assets as under:

(Source: Scheme Information Document)

The Scheme's investment portfolio typically will consist of investments made in shares of Indian companies listed on a stock exchange in India

The proportion of the Scheme's portfolio invested in each sector will vary to the tracked sector weights that are a part of broad well-diversified indices to ensure portfolio diversification. And the proportion of the scheme portfolio invested in each type of security within the sector will vary depending upon a comprehensive analysis of the company based on the Environmental, Social and Governance (ESG) factors impacting the company and their peer group within its sector of operations.

It is also stated in the Scheme's Information Document (SID) that the scheme will not invest either in Repo of Corporate Debt Securities, Securitized Debt Instruments, Foreign Securities or Derivatives.

Further, in accordance with SEBI Circular No. CIR / IMD / DF/11/2010 dated August 8, 2010, the aggregate asset allocation will not exceed 100% of the net assets of the scheme.

Quantum India ESG Equity Fund, under normal circumstances, shall not have exposure of more than 50% of its net assets in stock lending. The Scheme may also not lend more than 5% of its overall stock lending exposure to any one intermediary to whom securities will be lent.

What will be the investment strategy?

As you might be aware, India has embarked upon a national level cleanliness movement- "Swachh Bharat Abhiyan". The aim of this movement is clean length and breadth of the country, provide cleaner natural resources, improve hygiene and health and contribute towards achieving the sustainable development goal established by the United Nations in 2015.

Supporting the mass movement for cleanliness and sustainability, Quantum India ESG Equity Fund is a step towards ensuring that investments flow into greener and cleaner business.

The focus of Quantum India ESG Equity Fund will be on investing in businesses, which are ensuring sustainable management of natural and human resources, diversity within the organizational structure, prudent management and socially responsible framework of business.

The investment strategy determines sector weightages to reflect that of broad, well-diversified indices of the Indian equity markets.

Further, the strategy aims to invest in companies within each sector that stand high on the Environmental, social and Governance (ESG) parameters. The Scheme will invest in a basket of stocks after intensive analysis on the environmental, social and governance aspects of the company. The aim is to follow a comprehensive 'ESG Framework' in order to develop a deeper understanding into a company's management practices, sustainable businesses and risk profile, which would thereby help us in understanding the impact on long-term sustainability that drives performance.

The primary focus of the Scheme will be on companies based on two criteria:

  • First is for selecting companies under coverage; and
  • Second is for selecting companies in the portfolio

The first criteria is selecting companies generally trading with the liquidity of minimum US $ 1 million on an average over the last 12 months and second criteria based on their ESG score.

Each security, which is filtered on the basis of first criteria, will be scored on ESG parameters using data sources such as sustainability reports (GRI Framework), Business Responsibility Reports (BRR) and other publicly available documents. Active weights of a security within their respective sector will be determined by a composite ESG score. A higher ESG score of a security within the sector will have higher relative weight and vice versa.

The selection process ensures eliminating exposure to companies that rank poorly on ESG criteria completely. The sum total of the weights of securities in a sector will equal to the tracked sector weights of broad, well-diversified indices. The allocations focus on governance and sustainability; hence will be agnostic to valuations.

So, the investment process will consist of...

  • Benchmarking sector weights to that of broad well-diversified indices in the Indian equity markets

  • Stock selection

  • Portfolio Construction

The AMC's stock selection approach is basically based on ESG scores.

(Source: Scheme Information Document)

For the portfolio construction of Quantum India ESG Equity Fund, it is stated:

  1. The stock should generally have an average liquidity of minimum US$ 1 million over the last 12 months.

  2. Every Stock with ESG composite score equal to or above the threshold ESG score will be part of the portfolio.

  3. The AMC would generally not try to time the market and will add stocks that meet the ESG criteria on set rebalancing dates. Every stock in the portfolio will be bought and sold on the basis of weights allotted to it and will be value agnostic. The AMC will set sector weights for the portfolio in accordance with sector weights of a broad well diversified India equity Index.

  4. In case, there are no stocks with ESG score greater than or equal to the set threshold ESG composite score in a particular sector, the weightage of that sector is redistributed on a relative basis among other sectors, where the stocks meet the ESG criteria. Consequently, the weightages of individual stocks qualifying the ESG criteria within those sectors will also change accordingly.

  5. The AMC will periodically review and if necessary rebalance the portfolio typically coinciding with rebalancing of the underlying indices and/or quarterly. The AMC will also seek to periodically rebalance the portfolio on account of a new addition of stock, company-specific events and in case of a change in the view of the sector or the company.

The aim of Quantum India ESG Equity Fund is to provide the investors with an opportunity to have an exposure to sustainable investment option.

Who will manage Quantum India ESG Equity Fund?

Quantum India ESG Equity Fund will be managed by Mr Chirag Mehta, a Senior Fund Manager at Quantum Mutual Fund.

Chirag specialises in the field of Alternative Investment Strategies and has over 13 years of experience handling commodities and a total experience of more than 15 years. He has to his credit an MMS (Finance) and is a Chartered Alternative Investment Analyst (CAIA).

Chirag is also the fund manager of Quantum Gold ETF, Quantum Gold Savings Fund, Quantum Equity Fund of Funds, and co-fund manager for Quantum Multi Asset Fund.

Ms Sneha Joshi will be the Associate Fund Manager for Quantum India ESG Equity Fund. Sneha holds a PhD in Economics and has earned an M.A. in Economics from Gokhale Institute of Politics and Economics, Pune. She has over 6 years of experience in economic, credit and quantitative research. She joined Quantum AMC in August 2015, and prior to joining Quantum, was associated with Credit Capital Research as a fixed income research analyst.

How will Quantum India ESG Equity Fund benchmark it performance?

Quantum India ESG Equity Fund will benchmark its performance against the Nifty 100 ESG Total Return Index.

It appropriately represents and closely resembles the investment objective of the fund. The composition of the aforesaid benchmark is such that it is most suited for comparing the performance of the Scheme.

However, the Scheme's performance may not be strictly comparable with the performance of the Benchmark, due to the inherent differences in the construction of the portfolios.

About Nifty 100 ESG Index...

NIFTY100 ESG Index is designed to reflect the performance of companies within the NIFTY 100 index, based on Environmental, Social and Governance (ESG) scores.

The weight of each constituent in the index is tilted based on ESG score assigned to the company i.e. the constituent weight is derived from its free-float market capitalization and ESG score. Sector weights are based on free-float market capitalisation. Further, each constituent within the sector is ESG tilt weighted and capped at 10%. The index is reconstituted on a semi-annual basis. The number of constituents in the index could vary.

Companies engaged in the business of tobacco, alcohol, controversial weapons and gambling operations are excluded from this index.

The Nifty 100 ESG Total Return Index has a base date of April 01, 2011 and a base value of 1,000.

Click here to access the KIM of Quantum ESG India Fund.

Click here to access the SID of Quantum ESG India Fund.