BAJAJ BROKING
March 13, 2025
11 mins read
ESG Investing refers to an investment strategy of investing in business organizations that prioritize environment, society, and governance structure along with profitability. An organization with a robust ESG policy will have more transparent processes and it will be accountable to the community within which it functions. A study by NYU Stern Center for Sustainable Business and Rockefeller Asset Management has found a positive relationship between a company’s financial performance and implementation of ESF initiatives.
Environmental initiatives can range from restoring natural ecosystems and opting for sustainable sourcing practices to choosing practices that reduce the carbon footprint. Social initiatives could be employee well-being at the workplace or supporting employee education among others. A robust corporate governance mechanism is required to ensure that the business functions to maximize shareholder returns. Read more to find out the evolution, components, benefits, investment strategies, and challenges for ESG investing.
As the environmental, social, and governance aspects are increasingly becoming important considerations in investing, investors are using ESG parameters to evaluate whether businesses can survive in the long-term. ESG analysis not only helps an investor to identify corporates with sound business practices, but it also helps him weed out those corporates that do not follow ESG. The same study also mentions that ESG investing offers some level of protection during times of crisis. Therefore, investors aim to mitigate risks by investing in companies that incorporate ESG practices in business policies rather than investing in companies that do not follow ESG principles.
Ideally, a strong ESG-aligned policy increases the reputation of the corporate and targets business profitability keeping in mind the needs of the environment, society, and shareholders through a robust governance framework. Organizations that do not keep ESG at the center of their businesses are more likely to experience internal risks, instability, and loss of reputation in the eyes of stakeholders. Because of this, even investors tend to invest in businesses that think of various stakeholders along with monetary profits.
ESG dates back to the 1960s when social responsibility in investing started to make headlines. These social responsibilities pertained to a company’s responsibility towards society, environment, and the community as whole. Corporate Social Responsibility (CSR) became the buzzword in the 1980s as countries enacted legislation mandating corporations to share a certain percentage of their profits towards the betterment of societies. But even then, reporting on those spending had not yet been commonplace and the term ESG entered the investing vocabulary in the 2000s.
Earlier, ESG parameters lacked standardization of parameters and consistency in evaluation. In the recent years, there has been a strong push towards standardization and implementation of ESG initiatives along with ESG reporting. Now, ESG analysis is a vital toolkit for an investor while evaluating companies. There is empirical evidence that links ESG to greater firm value and higher profitability. ESG Investing is also a result of a younger breed of investors who consider a firm’s social and environmental impact while making investment decisions. Another factor that has made ESG investing possible is the widespread availability of ESG data for corporations. Today, several indices are used to score companies on the basis of ESG parameters. In India, NIFTY100 ESG Index is one such index where the weight of index constituents is based on the ESG score allotted to the organization. HDFC Bank, ICICI Bank, Bharti Airtel, Bajaj Finance, Tata Motors, and Tata Consultancy Services among others are the index constituents of NIFTY100 ESG Index.
Environmental
The environmental component of ESG encompasses several green initiatives related to carbon footprint, pollution, waste, sourcing, ecosystem, and agriculture. For instance, TCS has an initiative for optimizing water consumption. It employs rainwater harvesting, conservation, and sewage treatment in its efforts. It also aims to eliminate single-use plastic from its offices and recycle 100% of all biodegradable waste by the year 2025. Starbucks, as part of its 2030 goals, plans to reduce greenhouse gas emissions by 50%, conserve or replenish 50% of water, and reduce waste sent to landfill by 50%.
Social
Society comprises internal employees as well as external partners and stakeholders who are related to the business organization in some way. Starbucks offers compensation benefits to its employees that go beyond the mandated industry average. Through the Starbucks College Achievement Plan (SCAP), Starbucks partners can enroll and earn an online bachelors’ degree from Arizona State University. The SCAP initiative covers 100% tuition expenses. Diversity and inclusion is implemented across hierarchy in Starbucks. A substantial number of roles in retail, manufacturing, enterprise, and board of directors is filled with people of color and women.
Governance
A robust corporate governance mechanism ensures transparency and accountability to shareholders and the public. Kubota has several risk management initiatives pertaining to reliability of financial reports, prevention of illegal money transfers, compliance with anti-monopoly laws, etc. Investors can assess the efficiency of corporate governance based on several factors such as leadership compensation structure and transparency, disclosure norms, policy on resolving conflicts of interest, risk management, frequency of third party audits, relationships with key suppliers and customers, profile of the board of directors, and risk management frameworks. Some red flags in corporate governance include difficulty in removing irresponsible board members, huge discrepancies between executive benefits and median compensation, and non engagement of third party auditors.
ESG Investing has several benefits for investors some of which are mentioned below -
Improved performance of portfolio
As per Morningstar, around 59% of the sustainable businesses beat their rivals over a 10-year period in terms of financial performance. Therefore, investing in ESG-oriented businesses is not just doing good for the environment, but it also rewards investors through superior financial performance. McKinsey reports that a strong ESG focus positively correlates with increased revenue growth and cost reduction, thereby quantifying the positive impacts of ESG.
Rewarding innovation and adaptability
Having an ESG policy results in businesses to cut wastage, reduce carbon footprint, and go for eco-friendly alternatives. These create constraints and force businesses to adapt and innovate their business processes. Since ESG pushes corporations to use resources efficiently, this results in a long-term cost reduction that helps such companies stay competitive. Incorporating ESG goals in business helps organizations to anticipate legislations regarding climate change and mitigate those challenges by being adaptive in supply chains.
Rewarding the best practices in hiring and retaining talent
ESG Investing rewards businesses that go the extra mile in creating an inclusive workplace for its employees. When employees are a part of voluntary ESG initiatives, it helps them reconnect with their purpose and they feel more engaged with the organization.
Enhanced compliance
As per a McKinsey report, a strong ESG focus helps companies avoid the risk of adverse action by the authorities. In some cases, governments may also support businesses that display a firm commitment to ESG practices.
Harvard Business School recommends the following ESG investing strategies -
Positive and negative screening
The screening strategy can be adopted once an investor has a set of ESG parameters and some benchmarks. It can also take the shape of a particular area which the investor wants to exclude or include. For instance, if an investor wants to reduce the adverse effects of non-renewable energy sources, he may invest only in companies that are powered by renewable energy sources.
Portfolio tilt
A tilt strategy is employed when an investor tilts the allocation towards ESG investments while simultaneously decreasing the allocation towards non-ESG investments. The ESG investments must be in those companies that score highly on several ESG parameters and indices. A tilt strategy is less risky than a screening strategy because the available asset base is wider. In screening strategies, the investment base is narrower and therefore represents higher risk.
ESG Integration
This is a more long-term strategy than portfolio tilt and screening as it starts with a viewpoint on integrating ESG into the investable portfolio. This strategy may consider several ESG ratings at once and then select a set of companies that are projected to outperform the market over a long period. Instead of defining specific parameters and further benchmarks as done in screening strategy, ESG integration starts with incorporating ESG in the existing investment process.
Theme-based investing
This is a broad strategy compared to others in which the investor selects a particular theme and then finds a list of companies that adhere to that particular theme. For example, if the investor selects sustainability as the theme, then he needs to find a comprehensive list of companies that score high on different parameters such as water conservation, plastic elimination, and sustainable sourcing among others. Then, the investor invests in all those identified companies similar to an index fund.
As a signatory to the Paris Agreement in 2016, India has committed to achieve net-zero carbon emissions by 2070 along with focusing on increasing the share of renewable energy sources. Therefore, a move towards a green environment is a trend that works in favor of ESG investing in India. ESG Investing is also experiencing a surge due to corporations increasingly becoming aware of their responsibilities towards the environment, society, and other stakeholders. India has also seen investments in ESG businesses by global investment funds.
India has also seen an emergence of ESG-themed mutual funds that has further opened the doors of ESG investing to retail investors. Many of those ESG-themed funds invest in companies majorly in lending and IT. The domestic Asset Management Companies in India have also launched several ESG-based funds. Notable among those are Avendus that launched the first ESG fund in India in 2019. Quantum also jumped into the fray with its own ESG-based fund. Therefore, there has been a strong demand for ESG-themed investment opportunities from AMCs as well.
There has also been numerous legislations regarding corporate governance and policy initiatives in the renewable energy sector that has resulted in institutional investors adopting ESG investing. Launching of mutual funds and investments by institutional and retail investors in ESG-oriented asset classes have been possible through the development of indices such as NIFTY100 ESG Index, NIFTY100 Enhanced ESG Index, S&P BSE 100 ESG, and S&P BSE Carbonex among others. As we can see, ESG investing has seen a strong demand in India driven by several trends and numerous opportunities exist for investors who want to do their bit for the environment through their investing decisions.
Regulatory issues
In many countries, integration of ESG policies with business practices has not been made mandatory by the government and so, companies may not implement ESG initiatives even though they know the advantages.
Uniformity issues
What constitutes an ESG practice may not be uniformly accepted by all countries. Also, countries may have different reporting standards for ESG that results in multiple reporting practices in financial statements. There may not be an agreement on the tools and metrics to be used to link a particular ESG practice to a financial outcome.
Investment preference
Investors who are risk-averse may prefer investing in well-established asset classes or themes. For instance, categorization of mutual funds on the basis of market capitalization is a well-accepted diversification strategy. However, sectoral or thematic-based mutual funds narrow down the scope of investment and represent higher risk. So, ESG-themed funds may be shunned by conservative investors.
Availability of long-term data
In India, ESG-themed funds have been launched as recently as in 2019 and there is not enough data to evaluate the performance of such funds. Though there is empirical evidence linking ESG-practices to superior financial performance, a note by CRISIL mentions that NIFTY 500 Total Return Index offered higher returns than ESG funds. The note also mentions that extensive data regarding ESG funds is not available.
ESG Investing can be an exciting step in your investment journey. However, you need to remember some guidelines before making your first ESG-themed investment. Learn as much as you can about the different metrics within ESG and determine which of those truly matter. Once you have a ready list of metrics, start evaluating companies within different sectors. Something to keep in mind is that the maturity of ESG initiatives will differ across industries. Manufacturing-heavy industries that have factories in remote areas may have more well-developed ESG practices than the ecommerce industry.
Whenever you are evaluating companies, find out evidence that talks about past ESG initiatives in quantifiable terms. Outcome must be tangible for an ESG initiative. You also need to be careful of marketing claims and greenwashing because many organizations appear to be more environment-friendly than they actually are. Evaluating company financials is another step that needs to be done to weed out the companies that have weak financials. Companies that are running a slew of environment-friendly initiatives while being consistently unprofitable are red flags that you want to avoid. Once you are left with a handful of companies in each sector, you can either go for ESG investing for a particular sector or ESG investing for a particular theme across sectors. For instance, if you care about water conservation, you can choose to focus on only those companies across sectors that have noteworthy initiatives in waste water treatment and water conservation.
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This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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ESG stands for Environmental, Social, and Governance in investing. ESG Investing places emphasis on corporate accountability towards the environment, community, and governance standards so that it functions responsibly and transparently.
Traditional investing decisions are made on the basis of a company's financial performance, sectoral outlook, market outlook, economy, investment horizon, and investor’s risk profile. While all these factors are important, traditional investing does not consider a company’s responsibility towards environment, community, and other stakeholders as an integral part of its business operations. ESG Investing brings in the added component of accountability and transparency of an organization.
Incorporating ESG factors into investment decisions has several benefits. Investors can realize more returns in the long term driven by the company’s superior financial performance. There is empirical evidence that links ESG practices to growth in revenue and bottom-line. ESG Investing also pushes companies to be innovative and adaptive, which may result in better financial performance than peers.
There are several ESG investment options that are available in India. For beginners, there are nine ESG mutual funds such as SBI ESG Exclusionary Strategy Fund, Quantum ESG Best In Class Strategy Fund, Axis ESG Integration Strategy Fund, and Aditya Birla Sun Life ESG Integration Strategy Fund among others. If you do not want to go for ESG mutual funds, you can evaluate individual companies with best-in-class ESG practices and consider investing in them.
Investors may not find a uniform set of tools for ESG investing. Also, ESG reporting requirements vary across countries and there are no common financial reporting guidelines on ESG. For India, extensive data for ESG funds is not available because they have been launched as recently as in 2019 that may make evaluation difficult.
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