ESG – Is Impact Investing Profitable in 2022 Or Just Good For The Society? (2024)

Last Updated on Apr 25, 2022 by Aradhana Gotur

This article is written by Divam Sharma, founder and CEO of Green Portfolio and a former analyst at CitiBank, IMGC, and Kotak Mahindra Bank. Check out Green Portfolio’s smallcases.

What is ESG all about?

“Every cloud has a silver lining”. This quote certainly holds true for the COVID-19 pandemic. When the coronavirus hit the globe, the investor world started noticing factors they had been ignoring for a long time. These aspects are Environmental, Social, and Governance, aka ESG.

Also called Impact Investing or Socially Responsible Investing (SRI), it is an investment strategy that aims to generate financial returns with the ultimate goal of creating a positive social impact. In other words, it focuses on“How companies make money rather than how much money they make”. With the growing focus towards a more sustainable future, impact investing provides an opportunity for investors to invest and use their capital to address the world’s most pressing economic and social issues like renewability, climate change, agriculture, healthcare, education, housing and equality.

What is an ESG Score?

In order to have a complete understanding of Impact Investing, one needs to understand the ESG score. ESG scores measure the sustainability of the company. It can range from 0-100 based on various parameters. How well the company treats its employees to what measures the company is undertaking to improve the environment, every such aspect is taken into account here.

Listed below are a few examples where companies have faced criticism due to noncompliance with ESG factors.

• Satyam: One of the biggest corporate frauds of India, which led to the removal of a tech giant from Sensex, Nifty and tightening of corporate governance norms in India
• Vedanta: Large copper smelter ordered to shut down on environmental grounds in India
• Facebook: Global tech giant faces public backlash and fall in profits due to data privacy infringement
• Volkswagen: Millions of cars recalled by an automotive giant on account of falsified emission test results
• Manpasand Beverages: 40 cr. GST fraud wherein the company used fake invoices to claim the input tax credit

On the contrary, companies that rate high on ESG creates a lot of value on account of:

• Lower cost of capital
• Government support and subsidies
• Sustainable top-line growth with enhanced profitability
• Motivated employees

All are contributing to premium valuation for the company on a long term basis.

If an investor intends to see an improved working environment and decent employment, he/she can invest in companies that promote productive employment along with growth. Click To Tweet

Due to the dynamic nature of the business environment, businesses are continuously getting impacted by non-financial factors. Companies are now being evaluated on intangible factors which are not recorded in the balance sheet. The 17 Sustainable Development Goals (SDGs) of the United Nations provide investors with clear and strong guidance for impact investing. For example, Goal number 8 is “Decent Work and Economic Growth”. If an investor intends to see an improved working environment and decent employment, he/she can invest in companies that promote productive employment along with growth.

What is the global ESG Market?

Let us have a look at some numbers now. Globally, ESG investments have grown 36% since 2016, and the flow is maintaining its upward trajectory. The US and Europe continue to be the largest contributors, and within Asia and the Pacific, Australia, Japan, and New Zealand are the major contributors with a quickly expanding share. According to a Bloomberg report, Global ESG assets are on track to exceed $53 tn. by 2025, representing more than a third of the $140.5 tn. in projected total assets under management.

Data Source: Bloomberg quint (ESG by the numbers)

The graph given above shows historical growth in global ESG assets, mainly of five countries and predicts the numbers in three scenarios. I.e., Bear, base and bull run.

What is the status of ESG funds in India?

ESG funds in India range from 23, according to a Refinitiv report, even when India is the 6th largest economy in the world. Though ESG investments are at a very nascent stage in India, they are increasingly gaining traction in the country.

• NSE and BSE have become partners of the United Nations-backed Sustainable Stock Exchanges Initiative, committing to promote sustainable investing through improved ESG disclosure requirements of listed firms
• SEBI has mandated the inclusion of a Business Responsibility Report (BRR) as a part of the annual report for the top 1,000 listed companies
• The Economic Survey 2020–2021 of the Government of India (GoI 2021) explicitly recognised the need to integrate climate and financial policies and identified a host of measures driving ESG investments in the country. More than a dozen companies like Reliance Industries Ltd., Vedanta and JSW Energy have declared to become carbon neutral in the next few years or so.
• The Nifty 100 ESG factsheet, released by NSE, shows the growth of the index since 2012.

Not only this, but ESG funds were also observed to outperform the benchmark index, i.e., Nifty 50.

Data Source: Livemint

With higher returns comes higher risk. Not only does it have all the risks usually associated with mainstream capital placement; capital risk, transactional cost risk, exit risk and others; it also has what is known as impact risk. It is the risk that the intended impact will fail to materialise or that what benefits one set of stakeholders will have negative consequences for another. The investment may not bring out the positive impact he has been hoping for.

Bottomline

Impact Investing is gaining momentum with the increasing concerns towards a more green and sustainable future. It offers a huge opportunity for investors who want to bring out a positive change in the environment – be it corporate or social. The underlying principle is to invest in companies that are socially responsible, supporting a green environment with robust policies in place. What ESG funds need right now are a proper regulatory framework and quality data measurements. Every investor needs to understand the significance of ESG and how it can help them create a better future: financially as well as socially.