ESG Investing 101: How to Get Started
TABLE OF CONTENTS
There's a new buzzword in town. Chances are, you may have come across this popular phrase a LOT in recent times. It's everywhere - it's on social media, in your advertisements, and perhaps even in your inbox.
It's sustainable living.
Simply put, sustainable living is a set of lifestyle choices that can be sustained over the long term. It is future-friendly and environment-friendly. Today, sustainable living is rapidly influencing various areas of our lives - like the way we eat, dress, shop and even drive.
Interestingly, it is also influencing the way we invest.
ESG investing is proof of this fact. An acronym for Environment, Social And Governance, ESG investing is quickly gathering a great deal of interest in the global community of investors. Curious to learn more about this sustainable kind of investing? Let's get right into the details then.
What is ESG investing?
ESG investing is a kind of investment strategy that prioritizes investments in companies that are sustainable and environmentally conscious. It is a kind of socially responsible investing that encourages investors to choose companies that are committed to building a better future for the planet, overall. It requires investors to shift focus from companies that are merely profit-oriented, irrespective of the impact they have on the planet and the community they operate in.
As the name indicates, ESG is an acronym. It stands for the criteria that you need to take into account to evaluate the investments available. These criteria are:
- Environmental factors
- Social factors
- Governance factors
ESG criteria explained
To fully adopt the ESG investing strategy, you need to better understand what the three fundamental criteria are all about. Let's check them out one after the other.
These criteria include aspects like the use of clean energy sources, proper waste management, and conserving natural resources. You need to examine if the company you wish to invest in fulfills these criteria.
Here are some other things to look at to ensure the company is environmentally conscious.
- Water usage
- Air, water and land pollution
- Carbon emissions
- Deforestation and afforestation
- Green energy measures
To qualify as a sustainable investment option, companies also need to be socially responsible. It needs to give back to the society it functions in. Social criteria examine the company's relationships with its employees, creditor, suppliers, customers, and community at large.
Here are some areas to look into if you want to assess a company's social accountability.
- Data security
- Employee diversity
- Customer experience and satisfaction
- Human rights practices
- Fair labor practices
Governance criteria assess if the management behaves in an ethical manner, with integrity and honesty. Companies that meet these criteria are less likely to adversely affect investors' interest in the long run.
While checking this aspect of the ESG criteria, you can look into areas like the following.
- Diversity among the board members
- Contributions to political parties
- Lawsuits in the company's name
- Adherence to rules and regulations
- Lobbying and other corrupt practices
How to go about evaluating a company's ESG performance?
Well, you now know the details too look into as a part of ESG investing. But how do you find out if a company you are interested in performs well on the ESG scale? To evaluate this, you can rely on the following sources.
1. Corporate reporting
Generally, companies that are sustainable regularly publish reports of their ESG initiatives and progress. You could look at these reports to understand the company's ESG record better.
2. Third-party reports and ratings
There are also several third-party reports and expert ratings that you can rely on to understand how well a company meets the ESG criteria.
3. News about the company
In addition to the above sources, your everyday news can also be a good indicator of which companies are on the right path to sustainability.
For the average individual investor, assessing each company could be cumbersome. Fortunately, there are ESG funds, where experts put together portfolios of securities like equities and bonds that meet the ESG criteria.
What are ESG funds?
ESG funds are investment options in which the ESG criteria are integrated into the investment process beforehand. Essentially, they are thematic mutual funds that invest in the stocks and securities of companies that meet the ESG criteria. And, like all mutual funds, they are managed by experts called fund managers.
ESG fund managers choose the companies that meet the criteria in place and create a portfolio of the stocks and securities issued by those companies. And then, investors like you can choose from the ESG fund options available to invest in. The fund managers also periodically update the portfolio if needed, so the best companies on the ESG scale remain a part of the portfolio.
Simply put, they do the groundwork for you.
What is the ESG investing scene in India like?
Morningstar reports show that on a global scale, around $2.96 trillion has been invested in ESG focused funds. Clearly, the global investor community has been embracing the practice of sustainable investing.
By comparison, ESG investing in India is still in its nascent stages. But interest in this kind of investing is undoubtedly growing at a rapid pace. In 2019, Morgan Stanley conducted a survey that showed around 85% of retail investors in India were interested in sustainable investing.
ESG investing options in India
Currently, the Indian financial markets have a growing range of ESG investment options for interested investors. Top among these is the Nifty 100 ESG Index. Launched in March 2018, this index has been designed to reflect the performance of the companies within the NIFTY 100 index based on their ESG score.
Recent data shows that the Nifty 100 ESG Index has managed to outperform both the Nifty 50 and the Nifty 100 in the last 1 year and over the previous 5 years.
Taking cue from the successful performance of the index, the mutual fund industry in India quickly responded to growing investor interest in the ESG theme by rolling out ESG mutual funds. According to Morningstar, the number of ESG mutual funds in India stood at 10 as of March 2021.
While all of these funds factor in the ESG criteria, they are not all similar in constitution. Some of these ESG also invest in global stocks, others are passive funds, and yet others are actively managed. Furthermore, these funds also differ in terms of market cap preferences and sector selection.
What are the benefits of ESG investing?
ESG investing is beneficial to the society at large and to you - the investor. As an increasing number of individual and institutional investors show interest in ESG investing, companies across the world find more incentive to develop sustainable business practices. This, in turn, spells good times for the future of the planet as a whole.
On a more microscopic level, you also stand to gain a lot through ESG investing. Here are the top ways in which you benefit from investing sustainably.
1. Potential to earn better long-term returns
ESG investments could outperform traditional investments over the long run, particularly if this wave of interest in and support for sustainable investing continues into the future. So, investors with a long-term horizon could benefit from this.
2. Reduced risk
ESG funds also have a track record of being safer investments. According to a study by Morgan Stanley, sustainable funds displayed a lower downside risk than traditional funds across various asset classes consistently.
3. Better portfolio diversification
Investing in ESG funds also allows you to diversify your portfolio in a healthy manner. Since ESG funds in India invest across various sectors, market caps and even across borders, the overall risk exposure in your portfolio comes down.
Well, that should give you a good idea of the dynamic ESG investing landscape in India. In the coming years, sustainable investing is undoubtedly going to pick up pace. And as an increasing number of investors - both individuals and institutions - become a part of this phenomenon, the future may just seem brighter than it was before.
Read next: 5 STEPS TO SELECTING THE RIGHT INVESTMENT FOR YOU
How do you know which ESG investment option is right for you? For that matter, how do you know which investment option - in general - is ideal for your portfolio? Our blog outlines 5 steps to help you with this.
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