Environmental, Social, and Governance (“ESG”) investing has evolved in recent years to meet the demands of institutional and retail investors that wish to better incorporate long-term financial risks and opportunities into their investment decision-making processes to generate long-term value. This article provides an overview of progress made with respect to the current state of research in ESG investing.
Historical trends show that a business which has good ESG practices has potential to deliver good risk adjusted returns in line with lower cost of capital and improved operational performance.
*Percentage of studies showing
Data Source: Oxford report ‘From stockholder to stakeholder’ based on more than 200 academic studies (March 2015)
For instance, Company A which has good ESG practices has potential to deliver long term risk adjusted returns, will be less risky compared to company B in the same sector which does not.
Company A will typically be less likely to be exposed to tail risks. These risks are like environmental accidents or punishment from regulators. Thus will indirectly impact its profitability and sustainability over the long term.
As highlighted by the Global Risks Report published by the World Economic Forum. The top 5 global risks in 2020 are all Environmental in nature. This is starkly different from a decade earlier. Back then Economic risks dominated the business environment. Thus, ESG risks which may have been ignored earlier, are demanding investor attention now.
For investors to determine which companies are best equipped to handle. It has become essential to evaluate their ESG practices.
ESG scoring methodologies include a combination of both quantitative and qualitative elements. As per SEBI mandate, top 1000 listed companies are required to prepare a business responsibility report (BRR) every year. Based on these reports, AMCs draw their selection based on the top listed 1000 companies and then use their internal criteria and systems to assign weights to companies based on multiple criteria. Among these, companies which are engaged in businesses perceived as harmful from a social perspective, such as tobacco, liquor and gambling are dropped.
Furthermore, companies which have higher carbon footprint or rely heavily on water such as bottling plants or the ones which pollute air or water are given negative weights or altogether excluded.
In July 2019, we launched Quantum India ESG Equity Fund (QESG). QESG was one of the first ESG funds to be launched in India. While screening companies, we subjectively evaluate more than 200 parameters across the Environment, Social and Governance domains. Our focus has been on better disclosures, better performance with respect to gender inclusion as well as reducing the carbon footprint.
Here are some of the important parameters we use to select companies that make the ESG equity portfolio.
• 70% weight is given to companies on their ESG performance relative to their peers and national / global regulations on material ESG aspects.
• 30% weight is given to companies on their levels of disclosures provided in their sustainability reports / business responsibility reports / annual reports.
• Governance sits at the heart of our analysis because we believe governance shortcomings usually go hand in hand with poor performance on the social and environmental fronts
• While computing the ESG score, 50% weightage is given to the Governance aspect, and the remaining 50% to the Environmental and Social aspects.
We have built a portfolio of 40-50 companies that have more than the minimum cut-off of our ESG score. Our fund portfolio is purely based on ESG principles, irrespective of the PE ratio, or any other factors.
Low Score → Low Weight, High Score → High Weight.
For further details, please refer to SID (Scheme Information Document) of QESG.
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