ESG Investing Meaning: What It Is & Why It Matters?

Investors have nowadays begun to look beyond just profit margins and stock performance. Growing concerns about climate change, corporate ethics, and social impact have led to a shift in how investments are evaluated. As a result, there’s a rising interest in strategies that align financial returns with broader values. One such approach is ESG investing, also known as sustainable investing. 

ESG investing takes into account not just traditional financial metrics, but also environmental, social, and governance (ESG) factors, such as a company’s carbon footprint, labour practices, and board transparency. In this article, we will understand what is ESG investing, how it works and some common examples.

ESG Investing Meaning

The ESG investing definition can be stated as a method for investors to align their financial goals with a social, environmental, and governance cause. It has been in trend in the past couple of decades. The three aspects of ESG investments include:

• Environment: Businesses that either impact or protect environmental issues, such as deforestation, fossil fuel consumption, water usage, carbon emission, air pollution, etc. 
• Social: Businesses that either impact or protect social issues, such as gender equality, customer satisfaction, human rights, sexual harassment, etc. 
• Governance: Businesses that either impact or protect issues such as employee satisfaction, pay-scale inclusion, whistleblowing, corruption, lobbying, etc.

In ESG investing, investors analyse the above factors, ensuring that their investment does not just align with their financial growth but also positively impacts the environment, society or governance of the company. 

How does ESG Investing work?

ESG investing is straightforward, provided you set a definite goal. Let’s look at the steps: 

Step 1: Decide on a group of ESG factors that you want to include in the investment. For example, you decide to invest in a company that uses or produces green energy. 

Step 2: Conduct detailed research on companies or portfolios that have businesses supporting your ESG criteria. To help investors do so, research organisations provide ESG ratings to companies. These ratings are provided based on the business’s impact on ESG factors. 

Step 3: Screen the companies based on their ESG ratings and eliminate the ones with poor or low ratings. Investors can also screen companies based on a uniform ESG factor. This is called ‘thematic’ investing. 

Step 4: Create a portfolio of companies that align with your financial goals and have a positive ESG impact. 

Step 5: As an investor, you can use your shareholding power to help those companies improve their ESG contribution.

Why is ESG Investing important?

ESG investing has been trending for over a decade. To understand the reasons, let’s understand the benefits:

• Promotes Inclusive Capitalism: As ESG issues increase, it reinforces the requirement for investors and companies to align their financial goals with ESG factors.
• Growing Investor Conviction: Investors are increasingly integrating non-financial factors, such as climate risk, labour practices, and governance quality, into their analysis. This has led to the growth of responsible or sustainable funds.
• Enhances Brand Reputation and Customer Loyalty: Companies with a defined agenda for clean businesses are attractive to customers. Consumer loyalty and brand reputation impact the overall value and keep it resilient from sudden market changes.
• Changes in Environment: The environment is changing, and ESG investing creates the need for businesses and investors to run companies that will complement the needs of our society and environment. 

Growth of ESG Investing

India has experienced a notable trajectory in ESG investing over the past decade. Let’s look at the growth of this sustainable practice in India: 

• Transition Towards a Greener Economy

As per the Paris agreement, in 2015, India submitted a report termed as Nationally Determined Contribution (NDC) with promising action plans on how India will work towards reducing pollution and adapting to climate change. The report was updated in 2022, where the targets to benefit the environment were increased. The plan focuses on increasing the production and use of renewable energy and reducing the overall emission intensity. 

• Going Global

ESG factors like business ethics, corporate governance, and gender equality have led businesses to become more conscious and as a result, increased awareness. Due to this, more companies are recognising the benefits of ESG investing and are willing to invest in Indian companies. 

• Increase Interest Amongst Domestic Investors

With increased awareness, domestic investors are getting accustomed to sustainable business practices. In the past few years, the Indian market has witnessed the entry of ESG funds like Avendus, Quantum Asset Management and Invesco. 

• Introduction of ESG-favouring Reforms

Regulatory bodies such as SEBI (Securities and Exchange Board of India) have introduced various policies and reforms to promote sustainable business practices for investors and companies. 

The total worth of ESG funds in India is said to be close to ₹10,946 crore, with a net outflow of approximately ₹891.53 crore in 2023. Investors are gradually shifting their decision-making by focusing on both ESG factors and financial factors. The way forward for ESG investing in India depends on three major factors:

• 2070 Net Zero Target: India’s commitment at the United Nations Climate Change Conference held in 2021, to achieve net-zero carbon emissions by 2070. Owing to this, sectors such as power, energy industry, transport, etc, will gradually need to shift to ESG-favouring methods. 

• SEBI’s BRSR Mandates: The ‘Business Responsibility and Sustainability Report’ (BRSR) brought down the ESG parameters from 800 to 49. This change helps link financial performance with ESG metrics, making it easier for investors and shareholders to evaluate the overall potential risk and growth of the businesses.

• United Nations’ Sustainable Development Goals: The United Nations’ commitment to achieve its 17 goals by 2030 focuses mainly on the three core elements, such as environmental protection, social impact and economic growth.

Types of ESG Investing

ESG investing can be in different forms. Let’s look at some examples: 

• Negative Screening: It involves removing companies that have little to no ESG criteria incorporated in their businesses. For example, tobacco companies, businesses that involve child labour, coal mining, etc. 
• Positive Screening: It involves considering the businesses that have incorporated a considerable amount of ESG criteria. For example, green energy-producing companies, businesses that prioritise gender and cultural inclusivity, and businesses that have excellent employee satisfaction. 

• Thematic Investing: This involves a focused investment plan where investors choose businesses based on ‘theme’ or a singular factor, such as environment, social or governance. For example, businesses that build social communities, produce agricultural goods, or generate renewable energy.
• Impact Investing: It involves investors who consider both ESG criteria and potential ROI while approaching an investment opportunity. For example, companies offering affordable healthcare for the underprivileged, waste management and building schools and colleges.
• Shareholder Ownership: It involves investors who use their ownership power and collaborate with companies to improve their ESG standards. For example, criteria such as labour issues, gender diversity, climate issues, among others.

Examples of ESG Investing

Here are some of the most common ESG funds available in the Indian market:

1. SBI ESG Exclusionary Strategy Fund
2. ICICI Prudential ESG Exclusionary Strategy Fund
3. Axis ESG Integration Strategy Fund
4. Kotak ESG Exclusionary Strategy Fund
5. Aditya Birla Sun Life ESG Integration Strategy Fund
6. Invesco India ESG Integration Strategy Fund
7. Quant ESG Equity Fund
8. Mirae Asset ESG Sector Leaders Fund of Fund
9. Quant ESG Best-in-Class Strategy Fund
10. WhiteOak Capital ESG Best-in-Class Strategy Fund

Challenges with ESG Investing

Here are some of the common challenges of ESG investing: 

• Lack of Accurate Data: Investors find it hard to evaluate companies on ESG criteria due to the unavailability of reliable information. This has led to a decrease in the popularity of ESG investing in India. 
• Lack of Evaluation Standards: ESG metrics have not yet been properly standardised, making it hard for investors to compare companies and evaluate financial potential.
• Lack of Performance Record: Since ESG investing is relatively new, there is very little reliable data that proves a positive financial impact of ESG investments.
• Resistance to Change from Traditional Methods: Investors who prefer established options and old-school investment methods find it hard to shift to investing by considering non-financial factors.
• Lack of Awareness: As ESG investing is gaining popularity in India, there is still a large number of audiences who are not well informed of the benefits of sustainable investment practices.

Conclusion

ESG investing offers many benefits and adds diversity to a portfolio. While there are a few hurdles, such as high cost, lack of awareness, and irregular framework, that might deter the growth of ESG investing, the potential to benefit the environment and society is huge. 

With time, ESG investing is not just going to remain a trend but evolve to be a key attribute of responsible and sustainable business practices. 

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