What to look at before investing in ESG funds

News: Earlier this week, the National Stock Exchange (NSE) launched NSE Prime.

Environment, social responsibility, and corporate governance have of late emerged as key themes for investors in India.

The asset size of ESG funds has increased nearly five times to Rs 12,300 crore over the last couple of years.

In this context, recently NSE has launched NSE Prime, to strengthen corporate governance in India.

Experts say that companies that are part of the ESG or NSE Prime will not only benefit in the long term but will also have a better reputation and potentially command a premium on valuation in the long run.

However, despite their potential benefits, there are some concerns associated with ESG investments.

What is ESG investing?

It is synonymous with sustainable and socially responsible investing. While selecting a stock for investment, an ESG fund shortlists companies that score high on environment, social responsibility, and corporate governance, and then looks at financial factors.

What are the criteria’s used for ESG investment?

ESG funds use parameters such as greenhouse gas and carbon emissions, and employment generated to assess the ESG impact of the companies.

Thus, companies with higher carbon outputs such as tobacco manufacturers, coal miners, oil and gas companies, and fossil fuel-based power generators typically do not feature in ESG fund portfolios.

On the other hand, companies in the technology, renewable energy, healthcare, and FMCG space feature heavily in these portfolios.

What is NSE prime?

NSE Prime allows companies to submit to higher standards of corporate governance compared to the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations.

Some key requirements for companies to qualify for NSE Prime are,

A minimum 40% public shareholding

Mandatory segregation of the posts of chairman and ceo

Independent directors as chairpersons of the risk management

Stakeholder relationship Nomination remuneration, and audit committees.

Why it is needed?

The idea is to nudge companies to raise levels of corporate governance practice on their own. The creation of such a group of companies will result in better decision-making and protection of shareholder interest.

What are the implications?

Firstly, companies will be forced to improve governance and ethical practices, and act with greater social and environmental responsibility.

Secondly, it will lead to loss of revenue and profits in the long term for the companies that do not alter business models or become more environmentally sustainable. For instance, Globally, many pension funds and sovereign wealth funds do not invest in companies that are seen as polluting or socially not responsible.

Thirdly, encourages public investment in social development and environmentally sensitive sectors of the economy. For instance, cleanliness, skill development, expanded healthcare coverage, and education.

Fourthly, it will facilitate greater attention on issues such as climate risk, emissions, supply chains, labour rights, anti-corruption, etc.

What are the concerns?

First, the issue of “greenwashing” – It is an act of providing misleading information about how a company’s products are more environmentally sound. For instance, the World Economic Forum noted that greenwashing is a top concern among global institutional investors while selecting sustainable investments.

Second, Investment experts have also pointed to the tendency of fund managers to over-weigh certain stocks and companies. Notably, when most large investment-friendly companies have fallen short of the qualitative and quantitative parameters used for ESG investing.

Source: This post is based on the article “What to look at before investing in ESG funds” published in Indian Express on 27^th Dec 2021.