The global events of recent times have challenged how economies function, businesses operate, and households consume.
The investors are assessing businesses not only on basis of their fundamentals but also from the point-of-view regarding their responsibilities toward the society.
The investors are applying a broader lens while considering an investment decision, with the COVID-19 pandemic only fast-forwarding the change. Incorporating ESG (Environmental, Social, and Governance) principles into the portfolio construction process is thus, necessary to keep pace with the times both from businesses and investors' perspective.
These trends are increasingly visible in Indian business and markets as well. A significant proportion of companies today are looking beyond simple profit maximisation as their purpose and incorporating sustainability considerations amongst their core objectives.
The companies are willing to sacrifice some of their earnings to achieve this goal. The investors are demanding for ESG investment option, while companies are increasingly looking forward to becoming ESG compliant.
The regulators, too, have been looking to drive more responsible business conduct. SEBI in 2019 mandated top 1000 listed companies to come up with an annual Business Responsibility Report (BRR). This has helped drive the company disclosures on this front as well as build investor awareness.
The asset managers are absorbing these governing changes and are expected to provide suitable products to investors and incorporate ESG inputs into their core portfolio building process.
In terms of incorporating ESG investing principles in portfolio building, investors should ideally build them in all portfolio construction and not limit it to only the ESG-themed ones.
For the latter, we need to make these principles an inclusion criterion for businesses to get into your portfolio, going beyond the simplistic notion that excluding select sectors makes it a sustainable portfolio.
At the same time, basic requirements such as diversification, liquidity and regular monitoring of the businesses should always adhere to irrespective of one’s belief in sustainable investing.
One should not have a narrow approach to the ESG investment theme and confined to a couple of sectors only. Investors should realise that businesses across sectors can come up with sustainable practices and can offer investment options to construct a diversified ESG portfolio.
The corporates nowadays are increasingly providing ESG disclosures in their financial reports, this offers institutional investors to greatly focus on the investment theme while expanding the ESG portfolio across the market capitalisation spectrum in the Indian markets. However, investors, should not go with only one variable out of E, S, and G.
The relative importance of these metrics will always be dynamic and specific events may make lead to one metric gaining in relative importance. For instance, Covid-19 has led to 'Social' getting a lot more spotlight.
Investors while considering constructing a portfolio, should not only focus on present ESG credentials but also should have a perspective about the company’s future.
One should do extensive analysis across relevant business metrics and evaluate how the company is expected to deliver on sustainability count and what kind of promises the business hold in the future while broadening the investible universe.
The investors should be mindful of ESG related risks that companies might face, such as the worst environmental disaster an establishment can encounter or possibly fail in sustainability quotient.
In terms of market returns from the ESG portfolio, investors should build the right expectations. One should not be greedy and expect superior performance over the short to medium term, only by just following sustainable investing principles.
However, one can certainly argue that businesses focussing on sustainability are better positioned for long-term investment returns. There is evidence to support that companies that have focussed on sustainability have delivered superior investment returns even in volatile times or bear markets. This trend also remains the same for India, as well as across several market sectors.
Investors should not be apprehensive that corporates involved in economic and social issues are diverting from their fundamental business operations or adversely impacting their profitability.
In fact, they should request the same because impactful business action is central to resiliency. Understand as well that factors such as quality, business size, and sector can lead to ESG rating bias as well.If you are unable to adjudge companies on their sustainability credentials, the best options are to rely upon professionally managed sustainable products.
The quote was originally published in Money control in October 2020.
The opinions expressed are author's own. Fidelity International is not responsible for the author's opinions.