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How ESG investments gaining traction

How ESG investments gaining traction
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How ESG investments gaining traction 

Highlights

A decent exposure will be good to pocket and heart as well

There has been a growing trend of populations about their carbon-foot print they're creating while consuming a product or service. The greater consciousness is from being aware of the depleting resources, degrading environmental conditions and hence the sustainability of those businesses engaging in these activities. Investing has multiple styles like that of growth/momentum, value, etc. though all try to exploit the market gaps using their own metrics to generate returns.

The newer generation of investors who are more aware of these situations are attempting to profit by investing in those businesses that engage in environmental-friendly actions and also of those who mitigate their risks by adding contributions to these causes. ESG (environmental, social and corporate governance) is one such investment philosophy where the environmental concerns (climate change, sustainability), social concerns and corporate governance form the core factors for investment. This makes for a responsible investment on the ethical parameters.

Just because an issue isn't financially material to a company doesn't mean it doesn't matter to investors. There will be occasions when a socially responsible investor will buy or sell on the grounds that it's the right thing to do, regardless of the issue's direct financial impact.

ESG can yield interesting results that may not always feel comfortable, especially to traditional socially responsible investors, due to its novel combination of an inclusionary criteria and financial materiality clause. The Financial Times lexcon defines ESG as a generic term used in capital markets by investors to evaluate corporate behavior and to determine the future financial performance of companies. These non-financial performance indicators are added in investment considerations incorporated into both investment decisions and risk management processes.

The proponents of this theme believe that by including these factors, costs infuse into the corporates to implement these changes, but it would've long-term positive impact on the larger environment and society at large thus proving to be a sustainable business model.

According to a 2006 study called Cone Millennial Cause Study, millennials are more likely to trust a company or purchase a company's products when the company has a reputation of being socially or environmentally responsible. Half of those surveyed are more likely to turn down a product or service from a company perceived to be socially or environmentally irresponsible. ESG investing can take various forms. The S&P Dow Jones Index splits sustainability into two categories: ESG and green or low carbon.

The ESG framework of investing tends to capture more factors, while green is more focused. Environmental factors include waste management, water management, environmental resource use, environmental disclosure, environmental impact, and reduction of pollution and emissions. Social factors include stakeholder analysis, workplace mentality, human rights, diversity community relationships, corporate citizenship, and philanthropy.

Governance factors include board structure, management compensation, stakeholder impact, stakeholder rights and the relationship between management and stakeholders. This is a bit different from SRI (Socially Responsible Investing) began in '70s where investors mostly used negative screening methods to exclude investments in guns, tobacco, gambling and other vices, etc.

Should you get on the bandwagon? An important consideration is the performance attribution. ESG funds have had a nice run lately. Since its inception in late 2018, for example, Vanguard's US ESG exchange traded fund's return of 28 per cent has whipped its broad-market ETF's 17 per cent. Another factor to be considered is if more inflows are moved into these strategies/companies that fit the bill or contrarily if flows dry into those companies that doesn't fit here could impact their stock performance.

This doesn't make it for a complete guilt-free investing ride as many claims to be. That could be achieved through the Impact Investing strategy. Its considered the most advanced of the three kinds of sustainable investing (SRI/ESG). It involves generating a measurable environmental and social impact alongside financial returns. The two are not mutually exclusive.

As an investor, the purpose of any investment is to make returns while considering risks but also if one would like to build the social/environmental consciousness as a strategy then a decent exposure would find good to pocket and heart as well.

(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at knk@wealocity.com)

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