The world's largest pension fund of Japan which manages $1.3 trillion has recently decided to make a major shift towards ESG investing. What does ESG stand for? Ethical, Social, Governance (ESG) investing is picking up in a big way across India. It is all about investing in companies that are not destroying health, not destroy the social fabric and not destroying corporate governance. While the history of this kind of ethical investing or ESG investing is quite recent, it has been observed that such ethical investing does make a positive difference to portfolio performance. Since ESG investing is more sustainable and social tenable, it tends to sustain value better in the long run. But first what is ESG investing all about and what are the key components? Then let us look at the benefits of ethical investing and the socially responsible investing pros and cons.
1. ESG companies are leaders in their industry
The assumption is that a company cannot sustain leadership in an industry for a long time, unless they are able to make a positive difference to standards of governance and sustainability. Companies that destroy public health and the environment will soon face public resistance and will not be able to maintain leadership for a very long time. We saw that with cigarette companies in the US where health concerns are high; these companies have been forced to pay huge compensation and have also destroyed value over the years. That explains why cigarette companies, including ITC, are increasingly foraying into food and other FMCG products. Industry leadership is the starting point.
2. Forward thinking and better managed companies
The second consideration is ethical investing in companies that have displayed higher standards of management quality. This is subjective but when you see a forwarding thinking management, you can be sure that you have a candidate for ethical investing. Most forwarding thinking managements are extremely conscious of their accountability towards health, environment, public sanitation etc. The quality of the management and their commitment to the ethical cause makes them worthy of ethical investing.
3. Better at anticipating and mitigating risk
Most ethical companies believe that risk needs to be managed proactively. Their primary responsibility to their shareholders and other stakeholders is to reduce the risk in the business by anticipating problems. To protect the interests of the lenders, the company needs to reduce its financial risk. To protect the interests of its shareholders, the company needs to reduce its financial risk and operating risk. The third step in ethical investing is to focus on companies that manage future risk better. It is a sign of a management that is conscious of its ethical and social responsibilities.
4. Meets standards of corporate responsibility
This is a wide term but there are some key indicators. What do we understand by corporate responsibility? Any business operates within the confines of a society and hence social responsibility becomes paramount. A business should not be destroying the water bodies or destroying the soil in its area of operation. The business must not be destroying the livelihood of the less privileged people who get displaced by their factories. They must not manufacture and sell products that are injurious to health or could become a source of long term health problems. It is the combination of all these factors that makes a company socially responsible.
5. Has a strong focus on sustainability
For a business operation, sustainability has many definitions. The business is sustainable if its operations are not compromising public health or public safety. It is also sustainable if environment concerns are taken care adequately. The management should behave and act in such a way that the interest of the stakeholders is protected.
Does ethical investing create value?
This is a fundamental question that we need to ask ourselves. There are no clear answers because there is no history of ESG investing in the Indian context. To some extent, Shariah investing has tried that but that has more religious overtones. Ethical funds are picking up as a concept across the world. The fact is that even an intuitive ESG approach to investing is likely to be value accretive. After all, it is the companies that run 360 degree sustainable models that can actually wealth in the long run!