Living a healthy lifestyle in a holistic sense has become one of the defining characteristics of our time. Interestingly, this idea is not limited to just the way we live. This idea is widely accepted in the investment world. Today, we follow trends from sustainable living to sustainable investing. Sustainable investing is gaining popularity around the world. Investors want to own businesses that are inherently less risky.
ESG – An environmental, social and governance-based investment framework is the basis for defining a high-quality, low-risk business. Such businesses are expected to generate long-term wealth for investors by compounding profits.Also read: Why an ESG-aware investment ecosystem is so important for India
A company's high ESG score typically indicates that it operates with the utmost care in protecting the environment, fostering social value, and protecting stakeholder interests. Such companies follow high governance standards and transparency. Going forward, investments that emphasize ESG will become even more important. As interest rates structurally fall, investors are expected to allocate more money to equities in search of returns.
Many of these investors may be less aggressive and want to reduce their risk. The best way to achieve this is to invest in stocks of companies with high ESG scores, or products that invest in those stocks. A robust system that penalizes polluters and rewards perpetrators will also drive investors towards companies with high ESG scores.Also read: Mutual Funds: What are the ESG subcategories allowed as per Sebi framework? MintGenie explains
At COP26 held in Paris in November 2021, India committed to net-zero emissions by 2070. India's carbon credit trading scheme is scheduled to start in 2026. Companies that meet the target will be entitled to carbon credits, and those that underperform will have to buy the credits. This will impact corporate profitability and require companies to invest more in reducing emissions. While environmental responsibility is driving action from investors and promoters, attention to social values is also catching up.
A company's employee policies, product positioning, and social responsibility play an important role. Companies are also working on governance standards. Enhanced disclosure, increasing the role of independent directors, and introducing profit-sharing policies have helped many companies climb his ESG ladder.
Businesses such as tobacco, alcohol, and gambling are excluded from the ESG investment framework.
Some large companies in old economy industries such as cement, paper and metals have focused on improving their ESG scores and are now in a better position than their global peers. These stocks have the potential to attract investment from overseas institutional investors. Lending institutions are also issuing variable products such as green bonds and green term deposits to raise funds from green investors. Funds collected from such products are only lent to organizations that follow environmentally friendly practices.Also read: Critics of ESG investing need to take a closer look at the concept of ESG investing
In India too, many fund companies have launched ESG-focused equity schemes, both actively and passively managed.asset value INR10,946 billion is managed by 10 ESG schemes across the fund house. ESG frameworks are evolving and will impact the quality of business in the medium to long term. Therefore, in most cases, long-term investors invest favorably in these schemes.
For very short-term trading, for example intraday trading, ESG frameworks are of little relevance. As of now, there are no ESG themed indices of his that trade in the derivatives segment. There is an exchange traded fund that tracks the Nifty 100 ESG Sector Leaders TRI. A positional investor may consider it prudent to trade a stock considering its ESG score. Stocks with high ESG scores and breakouts to the upside may have more buyers.
However, stocks with shaky governance practices or off-limits stocks in the aforementioned ESG sectors may not have as many institutional investors even if they make an upward breakout. Some prop desks may want to trade some stocks with lower ESG scores on the short side, especially when there is negative news about the company.
Overall, traders and investors should give due weight to the ESG framework when initiating positions in stocks.
Shrey Jain is the founder and CEO of SAS Online.
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