ESG Investing Gains Momentum In India The key factor driving ESG-oriented investing is societal awareness across all stakeholders, particularly the younger segments of the population

ESG investing, an investing method that considers environmental, social and governance factors of a company while investing, has been picking up pace in India in recent years. "There's been a meteoric rise in ESG-oriented investing in recent years. As of 2019, global sustainable investment topped $30 trillion. That's up 68 percent since 2014 and a whopping tenfold increase since 2004," says a McKinsey report.

The uncertainties witnessed in the last decade, be it economic downturn or the pandemic or the climate change, have raised awareness about being mindful. ESG is thus becoming an increasingly important priority for Indian funds and investors. Some investors have launched dedicated ESG funds or portfolios. And, companies are today forced to come up with ESG-oriented systems in their operations to effectively implement, manage, and monitor these goals.

ESG investing takes into account business practices such as diversity in the team, climate impact, among others. "Every sector is being scrutinized today by experts and concerned citizens alike. In a time when information moves quickly and without hindrances, it would be hard for any fund in India, or anywhere else for that matter, to discount the importance of ESG. While some funds may have institutionalized ESG systems better than others, the broad acceptance of ESG is now prevalent across the industry," said Reihem Roy, partner, Omnivore. Every company Omnivore invests in is subject to independent ESG diligence and regular audits.

What's driving the change

The key factor driving ESG-oriented investing is societal awareness across all stakeholders, particularly the younger segments of the population. The access to information, in all languages and across tier I, II, III and above, enabled by social media and tech in general, has made them sensitive to environmental, social, and cultural issues.

"Many employees including top talent would now prefer having a role that creates a tangible impact over something that pays well. Investors recognize that a focus on governance can lead to long-term improvement in the performance of the company. Governments across the globe are incentivising companies for ESG-friendly initiatives. Overall, the growth in ESG-oriented investing is driven by a combination of these factors," said Ankur Bansal, executive director, BlackSoil.

BlackSoil has integrated ESG factors into its investment analysis and decision-making process. This involves considering ESG risks and opportunities alongside traditional financial metrics. It has created an exclusion list of sectors that it would never invest in. It scores potential investments based on the ESG scorecard that it has built as per the global ESG standards. Based on this, it shares with the portfolio companies ways in which they can improve their ESG performance.

Most funds take a similar approach today. For instance, Java Capital takes factors like equal opportunity, fair pay, and a safe working environment for all employees very seriously. It supports founders who demonstrate high integrity and it periodically monitors governance practices in its portfolio firms. Many funds have also allocated a significant corpus for investments in climate tech and sustainability.

Several regulatory initiatives, including the Securities and Exchange Board of India (SEBI)'s disclosure requirements for ESG reporting, have also contributed to the growing importance of ESG in the Indian investment landscape. For instance, India's business responsibility and sustainability reporting (BRSR) has become mandatory for the top 1000 listed companies this year.

While the social and governance factors have been important for many years, the environmental aspect in particular has become increasingly important in attracting venture funding in recent times, say experts. According to a HolonIQ report, climate-tech firms in India have attracted $3.7 billion in funding in 2022. "This is a 6x increase from funding in climate tech firms in 2021 even by conservative estimates. This increase, especially in a year when overall funding in the Indian startup ecosystem was down by 40 per cent over 2021, is testimony to the fact that there is a renewed focus on climate tech investments in India. Over the last couple of years, there is an emergence of not only climate-focused VC funds in India and globally but also many VC funds are making climate tech a key focus area in their thesis," said Bhargavi Vijayakumar, co-founder and partner, Java Capital.

Creating value for funds and portfolio companies

Since ESG parameters are mostly non-financial factors, do considering these factors over bottomline yield the best financial results for the company and thereby the investors? They do, say investors.

"An ESG system is essentially a toolkit to help predict what can potentially go wrong for the environmental and social externalities of a business. These predictions help tremendously with safeguarding business models against risks that are avoidable when approached in the right way. Most fund managers agree that an ESG-first approach to investing significantly reduces portfolio risk. While in terms of downside protection, an ESG-first approach safeguards against social, environmental, and reputational losses that can (justifiably) bring down a company. The upside opportunities also increase when high-quality ESG-first deal flow is introduced into an investment pool seeking quality returns that meet today's criterion for responsible investing," said Roy.

Investors believe that companies that do well on ESG targets, also do well on financial targets. "They tend to attract lower cost of capital, see lesser attrition, also incur lower costs due to better energy and resource management and see lesser business disruption on account of stakeholder conflicts," said Shruti Srivastava, early-stage VC, climate and sustainability, Avaana Capital

Most firms today believe that companies with robust ESG practices outperform their peers. Java Capital's Vijayakumar tells us three key ways in which ESG parameters help investors and firms.

• Good ESG practices lower potential risks that a firm could run into which increases the probability of higher returns for investors
• Good governance practices lead to better operational efficiencies
• A firm projecting itself as one that prioritizes ESG enhances its reputation and brand value
• It helps in attracting the growing sustainable conscious customer base and in retaining talent

CSR vs ESG

ESG is often compared to CSR (corporate social responsibility). However, unlike CSR activities, financial performance of companies will depend on how well ESG targets are met. This is because while CSR focuses on volunteering and charity, ESG offers a quantitative measurement of sustainability.

"Research has shown that companies that perform well on ESG metrics can be more resilient to risks, have lower cost of capital, better prepared for climate change impact and enjoy a better long-term financial performance. However, it's important to note that there may be variations in the extent to which ESG performance affects financial performance, depending on factors such as the industry, market, and business model of the company," said Bansal.

"We feel a clear ESG track record that signals intentionality makes a company more likely to raise follow-on funding, attract conscious customers and vendors, and position itself for sustainable long-term growth," added Roy.

Besides addressing looming threats like climate change and social injustice, an ESG investing strategy offers higher returns as well. Thus, more and more funds are expected to join the ESG investing bandwagon.