Should investors jump on to ESG bandwagon?

Human progress has always come at a cost be it either hurting fellow humans, other living beings or to the Earth itself. At each of those inflection points, we've corrected ourselves to enhance those shortcomings and ensured the progress continued. Be it during the Industrial revolution when the workers were subjected to unhealthy working conditions or deforestation phase of expansion when animals were being extinct; corrective measures like employee benefits, better working conditions and forest conservation were taken up.

There has been an increasing awareness around climate change among the larger public and it's no more a discourse among the scientific, academic and research crowd. Governments on their part have been dilly-dallying the actions to adhere to previously agreed upon framework, but politics have always been the spoiler. Ever since the Paris Agreement, the corporates have also slowly swung into action as various stakeholders began to question the modus operandi. We've seen activism across the spheres of judiciary and shareholders also in coming out with concrete action plans in addressing this growing concern. Similarly, the post-GFC (Global Financial Crisis) world has witnessed some of the worst wealth inequality among various societies and polity, corporate and activists have raised concern on a consistent basis to tackle this.

The mega-corporate and accounting scandals at the beginning of the millennium made the regulators to take stringent regulations to contain such repetition. This has brought a minimum expectations and guidelines for each corporate to function including various redressal mechanisms to help the distressed stakeholders get the justice. Though has been on fringes for a while, the finance industry is taking an increasingly central role in how the funds are allocated and project funding is carried out. These factors are thus broadly form the basis of the ESG (Environment, Social and Governance) investing in finance. Earlier, this was restricted to some hedge funds which were judging the various industry participants on their metrics, but now with the awareness growing among the investors, it slowly has turned mainstream. The Covid pandemic and the subsequent changes to the investor psyche has only increased the momentum towards this form of investing which was a mere fad for the last few years.

Now, we find multiple investing avenues including MFs (Mutual Funds) have brought this philosophy available to broader investing community. This has also pushed the corporates to scurry in setting up the desired steps to ensure they don't be excluded on this basis in their fund-raising efforts. In one of the 'Morningstar' survey's, roughly 72 per cent of the investors, are at least interested in ESG or sustainability investing with 44 per cent either somewhat or very interested. Almost 9-in-10 consumers think companies should pursue ESG practices, about 86 per cent of the employees want to work for a co that shares the same values as they do, according to a PWC survey.

The idea behind the ESG investing is getting the activism to action and thus forcing the hands of the company managements to act in adherence to the greater good beyond the profitability. Ever since, Milton Friedman echoed in a seminal essay that the social responsibility of business is to increase its profits, the western corporate board rooms have largely embraced this idea. While we've witnessed the scourge some of the actors have done, the capitalistic view always incentivised the expanding profitability. Through ESG investing, a way to incentivise actors that serve beyond the profits is being propagated.

Tariq Fancy, a former chief of sustainable investing at BlackRock argues that, to fix the system we need to fix the rules. He says that the corporate world has mangled Friedman's message as he points that, in the same passage the author argues the responsibility of protecting society fell to civil servants, whose authority business executives shouldn't usurp as such roles 'must be elected through a political process'. In fact, Milton called the idea of business executives taking on a roll to be 'intolerable' on the grounds of political principle.

What Tariq argues is that ESG is a domain of the governments than a turf of the corporates. It's by diktat or rules, the governments could ensure the broader society is benefitted or not. Opponents like Andreesen (one of the largest tech VC) opine that impact investing is like a houseboat - not a very good house, not a very good boat. This argument is bolstered when one finds that 'facebook', the social networking major is still in the ESG indices despite some incriminating evidence of their platforms' adverse impact (addiction/manipulation, etc,) on the overall society.

Of course, the broader problem is also due to the lack of any standard ESG metrics or a benchmark, so have derived their own ways to valuate a business on the ESG front. The latest SEBI's (Securities Exchange Board of India) guidelines in this regard is a welcome development. According to the consultation paper, the name of the scheme accurately reflects the nature and extent of the scheme's ESG focus, provide transparency on investment policy, strategy and approach used for screening the companies. These steps could restrain investors tempted from greenwashing, where companies mislead their consumers/shareholders by making them believe/claim as environmentally friendly or sustainable.

Personally, I'm not excited about ESG investment as its concentrated to a few sectors like tech, banking/financial, (questionable PSUs), etc., purely due to the regulatory overview or business environment they operate in and don't share the lofty ideals they set to achieve. However, investors could explore ESG from the risk perspective for the same reasons just mentioned to diversify the risk in their portfolio.

(The author is a co-founder of 'Wealocity', a wealth management firm and could be reached at [email protected])