We are increasingly waking up to terms such as
Sustainability, Responsible Investing and
Environmental Social Governance (
ESG). What do these terms exactly mean? ‘Sustainability’ is a broad term that encompasses all of a company’s efforts to increase its positive impact on the world. ‘Responsible Investing’ on the other hand is an approach to investing that incorporates ESG factors into investment decisions. If one goes by recent data, Global ESG-focussed assets are expected to exceed $53 trillion by 2025 representing more than 1/3 rd of the estimated $140.5 trillion in total assets under management. These have already increased sharply from $22.8 trillion in 2018 to $30.6 trillion in 2020.
The heightened focus on ESG by investors is driven by five key factors:
Governmental support for sustainability
Population growth, urbanization, and consumerism is driving increased demand for food, water, energy and land putting enormous pressure on these resources. The exploitation of these resources on a large scale is clearly not sustainable. This coupled with uneven economic growth is leading to rising income disparity necessitating Government action. In 2005, the UN invited the world’s largest institutional investors to join a process to develop the ‘Principles for Responsible Investment’ (UNPRI). Driven by this agenda, organizations such as IFC and World Bank have set out guidelines such as IFC Performance Standards and World Bank Environmental, Health and Safety Guidelines. Further, in 2015, member states of the UN adopted “The 2030 Agenda for Sustainable Development”. At the heart of this are 17 Sustainable Development Goals which are an urgent call for action by member countries. The Paris Agreement on Climate change is also a by-product of this agenda.
Investor mandate and increased activism
Government-supported capital pools including sovereign wealth funds, pension funds, IFC, World Bank, multilateral institutions such as CDC, DEG, FMO, ADB, Proparco, have made adoption of ESG principles mandatory resulting in higher awareness and increased adoption by recipients of capital from these institutions. In India, both SEBI and NIIF (India’s sovereign fund) have mandated the adoption of ESG principles. In addition, public market investors are increasingly activists on the ESG front.
In October 2020, Government Pension Fund Global (the world’s largest sovereign wealth fund from Norway with over $1 trillion in assets) excluded the shares of a well-known garment manufacturer from its investment list and sold all shares held in the company due to alleged sub-standard working conditions and labour policies at one of the factories. There are many such examples across on funds and brokerages recommending selling shares of companies on ESG related concerns.
Better risk management and stronger returns
Over the years, investors have realised that the integration of ESG in their investment decision has led to better compliance and more transparent business practices, thus reducing risk and adding significant value to their portfolios. There have been numerous studies undertaken to measure the co-relation of ESG practices to overall financial performance. These studies have concluded with overwhelming evidence that companies that embrace ESG practices do well financially and generate strong returns for investors. As per an IFC study on 656 of its portfolio companies, companies with good ESG principles outperformed their peers by 2.1% on return on equity and by 1.10% on return on assets. Similarly, companies with high ESG scores outperformed by 1.30% the MSCI Emerging Market Index
Improved employee productivity and opportunity to reduce cost
An important element of ESG is the implementation of employee health and safety (EHS) measures. Good Social and EHS measures such as fair wages, better working conditions, policies to discourage discrimination and harassment, diversity, and regular training, help an organization retain talent and improve employee productivity.
Further, due attention to environmental factors provide organizations with an opportunity to substantially reduce costs especially in areas such as energy efficiency and resource utilization.
Conscious customers and focus on reputation and brand value
Customers today are increasingly conscious of ingredients in the products they consume, where from and how they are sourced, fairness in the buying process without exploitation, traceability to source, etc.
This allows businesses to tap into a new set of customers, who are even willing to pay a premium for products with these attributes. Investors strongly believe that the adoption of fair, transparent and ethical business practices also builds reputation and consequently increases the value of the brand and the businesses they have invested in.
In summary, ESG is here to stay for good as there is ample evidence of the benefits accruing to businesses and investors embracing it.
The blog has been authored by Mahesh Parasuraman, Co-Founder and Partner of Amicus Capital, a mid-market PE fund focused in India.
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