Combining mammon and morals SURAJEET DAS GUPTA

ESG funds are gaining traction in India but conceptual and practical questions about them abound still

The $1 billion fund announced recently by three former Tata executives — Mukund Rajan, Alan Rosling and Govind Sankaranarayanan — in alliance with Quantum Advisors wants to invest in small- and mid-cap listed stocks. But this is only part of their strategy: They also want to play an active role in the companies in which they invest to ensure they comply with the objectives of the fund.

On the other hand, KKR-backed Avendus Capital, which is raising a similar amount, wants to take minority stakes in the top 100 companies by market cap. It, too, will attempt to influence management decisions but it is not looking for an active role.

Two funds, two strategies but both purport to be part of the latest trend in global investing: ESG (Environmental, Social and Governance) funds. A post 2008-crash development,

ESG funds purport to look beyond a company’s financial performance to other factors that may materially impact corporate performance. Such investors also study parameters such as environment (climate change), social (health, safety and human rights) and governance (quality of management or board independence) when investing in a company. Globally some $26 trillion has been sunk into such funds.

A lot of groundwork has already gone into enabling investments in ESG funds. The MSCI, for instance, runs an ESG Index for institutional clients that tracks and rates about 200 Indian companies and hopes to double that number this year. And the experience of “impact funds,” which are similar to ESG funds except that they focus on companies producing products and services that promote sustainability, also provides a handy measure.

Belgium-based Incofin, an impact investment firm, has funded and even sold its stakes in Fusion Microfinance (which serves unbanked women) as well as in Anapurna Microfinance for decent returns. Last year Kotak Asset Management became the first in India to sign the United Nations-supported Principles for Responsible Investment, which tries to integrate ESG practices into investment policies and practices. And even State Bank of India has joined the bandwagon — it has renamed one of its older mutual funds SBI Magnum Equity ESG Fund.

The two new-mega funds have ambitious plans. Rajan, who was brand custodian to the Tata group, says they are looking at investing around $50 million in some 20 mid- and small-cap listed companies. “We would like to see at least a 10 per cent stake in the company and become the second-largest investor after the promoter. Our aim is to play an active role in implementing the ESG programme,” he says.

The horizon is long-term with an exit route of seven-eight years. To identify targets, the fund is building an internal team that will score 4,000-odd companies on ESG parameters.

Andrew Holland, CEO of Avendus Capital Public Alternative Strategies LLP, the fund will focus on 15-20 companies and has tied up with Institutional Investor Advisory Services to create a ranking framework based on ESG principals. The fund will also track the invested company by scoring its ESG performance once a year.

If ESG funds appear to combine mammon and morals, market analysts point to multiple downsides. One, many investors say that ESG funds’ return on investment is lower than normal funds because the companies in which they invest face rising ESG compliance costs and, therefore, lower profits. Two, some say ESG is mere “packaging”; most of the companies they choose would also be in the list of, say, a mutual funds based on the BSE 100 scrips. Three, questions have been raised on the arbitrariness of rating companies on ESG performance. This is a global problem — for instance, American Tower Corporation was rated at the bottom as well at the top by different rating agencies on ESG parameters.

The same challenges seems to be evident in India. The MSCI Index, for instance, puts companies in tobacco or alcohol or using fossil fuel in the negative list. But as Rajan points out: “You cannot be a purist in choosing companies, one has to look at its intention as well.” So for him Tata Power might be dependent on fossil fuels, but it has put up a plan of action that by 2025 when 40 per cent of its revenues will come from renewable energy, which makes it an attractive ESG bet. An analyst says, ITC might be in tobacco but it could be in the ESG fund list because it scores high on corporate governance and its intention to reduce its dependence on tobacco and move towards consumer goods and other sectors could make it a good bet.

Avendus is assigning a higher weight for companies with good governance parameters and much less to environmental and social ones, principally because the latter two are more difficult to achieve. Holland, however, says if governance is in place all the other parameters become easier to achieve.

Both Holland and Rajan aver that criticism that ESG funds give low returns is a myth. The MSCI ESG India Leaders Index has continuously outperformed that of the MSCI India Index, the point out. And the trend is similar, globally too. The question is whether ESG funds will catch on as they did in other global markets. With corporate governance suddenly leaping to forefront of newspaper headlines in India — from ICICI Bank to IL&FS — ESG funds in India may find more takers than the cynics suggest.