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Over the last few years, investing through funds has gained considerable popularity, and investors across the globe are looking to give their savings an exposure to the equity markets.
In this process, a number of diversification and growth strategies have come forward. In the traditional methods of investing, fund managers usually crunch the numbers and keep their purview of qualification limited to technical indicators, company leadership and the company’s financials in addition to the position of the business model in the context of the larger economy and future developments. ESG funds essentially take a different approach to curating investment opportunities by selecting companies based on three criteria - and these are environmental impact, social factors and governance factors. This does not mean that ESG funds leverage a strategy that is disconnected to the traditional principles of investing. From another angle, ESG strategies are essentially a product of the traditional approaches to investing. Let’s see, by understanding what really drives ESG funds, and what the craze is all about.
To help you understand why you should care about ESG funds, you first need to know that ESG companies account for a major chunk of assets under management across the globe. To be precise, they account for $22.9 trillion worth of assets. Other estimates suggest that every one dollar of four that is invested can be qualified as an ESG investment. Well, ESG-compliant investment opportunities are everywhere around you, and there is a reason why everyone is talking about them.
ESG funds essentially invest in companies that take a green approach to their businesses, make socially responsible decisions and promote good governance policies. Some analysts premise the performance of ESG funds on a few beliefs that seem to make sense when we look at the global economy holistically. Let’s see how. Consider two cement producing companies, one of which is actively working to produce their cement with zero carbon emissions. The other company, however, is simply leveraging traditional methods of cement production, and continues to operate on a significant carbon footprint. Which company will perform better financially? Well, in the short run, the latter company might be able to maintain a cost advantage and deliver slightly higher returns, someone who thoroughly understands the scope and potential impact of climate change will bet on the former company - because their practices are sustainable in the long run.
Now consider a similar example but let’s keep our focus on the S of the ESG. Consider a nuclear energy company that disposes their nuclear waste in the vicinity of the power plant - and as a result, is exposing the nearby communities to hazardous, radioactive waste. However, there is another company that leverages modern waste disposal techniques like deep geological disposal as a socially responsible step in the process of doing its business. An ESG strategy will bet on the latter company, because it places value on conducting business in a socially responsible manner to keep it sustainable in the long run. The former company might simply be banned by the regulatory authorities, or face resistance from the learning communities. The logic is not rocket science.
Well, so what can we say about the performance of ESG funds? There are multiple things to be considered in the process. When we talk about socially conscious business, do we bet on a company that promotes diversity in their teams or hiring strategy, or one that is committed to educating the communities that it depends on? When we are talking about sustainability, do we favour a company that uses clean energy, or uses recyclable components, or one that operates on the smallest carbon footprint? Depending on the causes that are chosen as qualifiers, ESG funds can return variable performance. In the US, most ESG funds outperformed the S&P 500 index’s returns over the year. According to Forbes Advisor, however, qualifying funds on a certain ESG dimension can be difficult to correlate with growth - giving adequate exposure with effective diversification ultimately requires one to look beyond just ESG funds.
In India, ESG funds like the Axis ESG fund have returned 30%+ over a span of nine months, while other ESG funds like the ICICI prudential ESG fund have returned a mere 10% since inception. Returns across ESG funds vary drastically. But in the US stock markets, 44% of the ESG funds can be spotted in the top quintile, while only 10% can be spotted in the bottom quintile in terms of performance. This shows that there is a significant variability, but ESG funds might be an excellent means of diversifying your existing portfolio.
However, 84% of investors are actively considering adding ESG funds to their portfolio today. But in the background, some pressing questions remain, and also makes one wonder about the ethics behind an ESG based strategy. Do some causes pay off better than others? Is it more valuable to invest in a company that promotes diversity in their governance and leadership profile, or should we choose ones that empower women? More importantly, which social causes actually qualify as socially responsible causes, and how will funds based on ESG strategies perform when some sectors or commodities post significant growth? While these questions remain to be answered, analysts suggest that ESG funds might be particularly helpful for people that are easily swayed by short term market movements - and that ESG funds can help them stay invested through such times, since the companies that they have invested in share some values that are dear to them! What is your take on ESG funds?
Interested in finding out about new avenues of investment? Then log on to www.angelbroking.com to discover more, with our free reports and other resources!
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