ESG Investing – The Biggest Alpha Generator in a fast transitioning investment landscape

“Profits are in no way inconsistent with purpose—in fact, profits and purpose are inextricably linked.”

Larry Fink, Blackrock

Over the last few years, ESG investing has become quite a rage as evidenced by the number of funds and indices that have been launched. There has been a rising recognition that companies do not function in a vacuum, affecting lives beyond what they directly serve. 

What is ESG ?

E – Environment, the use of natural resources by the company and the effect of its operations on the environment. 

S – Social, relates to the company’s relationships with people and institutions in the communities where it does business including its employees, suppliers, customers and society at large. 

G – Governance, the internal systems the company adopts to govern itself, the rights and responsibilities of the company. 

Contrary to belief, interest in ESG is not only in demand by the younger millennial investors who are more socially conscious, but also large institutional investors. ESG funds are amongst the fastest growing globally, with almost 25% of institutional investors now branded as ESG. They’ve grown at about 22% per annum since 2006. 

How Does ESG impact companies ?

ESG principles essentially help companies make better and more efficient use of resources –whether natural and man-made. This helps businesses sustain for longer – with the same “limited” pool of resources. 

Growth in Topline – Companies are better at developing long term sustainable business plans. Authorities also trust such companies more, enabling them to gain quick approvals leading to topline growth. Increases brand loyalty, McKinsey research has shown that customers say they are willing to pay to “go green.” 

Cost Savings – Effective utilization of resources leads to cost saving. Research by MSCI has found such companies to be better managed and more competitive than their peers leading to higher profitability and free cash flow.

Minimizing Regulatory Intervention – Helps engender government support and ease regulatory pressure. It also helps reduce companies’ risk of adverse government action. There are many examples of projects not taking off due to opposition from the local community.

Higher Productivity – Attract and retain better quality employees and increase productivity overall. Higher employee satisfaction is positively correlated with shareholder returns, generating higher returns of almost 3-4% . 

Lower Risk – Better risk management and compliance mechanisms reduce probability of occurrence of any extreme events like fraud, litigation etc. Higher risks result in bigger drawdowns. Non-ESG companies could bear almost 28% more risk. 

Enhanced attention from institutional investors – Foreign investors especially in India usually prefer companies with good ESG business practices. The information asymmetry is also a factor since high ESG companies are usually more transparent. 

Higher Valuations & Return to Shareholder – All of these factors result in companies commanding higher valuation. They also tend to be less volatile with lower betas. In fact companies hit by major ESG events saw their stocks underperform by 12% vs the index. The outperformance can be seen in the chart below

How to invest in Top ESG companies ? 

There were just 2 mutual funds in 2019, there are now 10 with an AUM of 10,500 crores. 

Another way to get exposure, with far more control is via Smallcases. You can see the performance of various mutual funds and smallcases compared to NIFTY100.

Why MWG ESG ?

MWG ESG follows a ESG + Quant strategy to eliminate human biases in investing. Developed by Salonee Sanghvi, CFFA after 17 years of experience in the financial markets it follows a bottoms up approach without a sector bias. A diversified portfolio that picks from Top 80 ESG ranked companies with strong risk management systems to ensure the downside is protected while giving you the full upside. 

The only ESG smallcase which has been back tested across multiple market and economic cycles. Last one year has been a roaring bull market and most stocks have given extremely high returns. A portfolio must be robust to perform across various market cycles like a bull market, a bear market and a consolidation phase.  Rs 1 Lakh invested in Oct 2007, close to the peak of the market would become Rs 10.5 Lakhs today.

Once considered a niche thematic approach to investing, ESG has quickly become an important fundamental factor for investors. The magnitude of investment flow suggests that ESG is much more than a fad or a feel-good exercise. So get ahead of the trend and ensure ESG Investing finds a place in your portfolio.