Tuesday 19 November 2019 8:36 amCFA Institute Talk

India and the ESG challenge

What is city talk? Info Info. Latest
These are articles written by professionals for investment professionals. They are contributions from external subject matter experts who do not work for CFA Institute, but may be a CFA charterholder as well as a member of a CFA Society. All are experts in their field and strive to deliver useful insights that help investment professionals make better decisions.

The year 2019 is setting records and not the kind our planet would have liked. Not only will 2019 be among the hottest years recorded, but July was the hottest month in the 140 years that temperature records have been kept.

Climate change is for real, and in India, our challenge is grave. Current and previous monsoon seasons may have been normal, or close to normal, but such categorisations don’t reflect the floods in Kerala and the mountain states or various droughts happening simultaneously.

Nine of the ten most-polluted cities in the world are Indian. We are also among the top three nations for air pollution–related deaths. But the air quality is only one aspect of our climate change dilemma. Even if we solved our air pollution problem tomorrow, cities such as Mumbai and Chennai would still be at risk from rising seas.

Need to manage resource consumption

And India isn’t alone in South Asia. Indonesia’s president, Joko Widodo, has announced the country’s capital will shift from Jakarta to a new site in East Kalimantan. The decision reflected economic considerations, but also acknowledged an uncomfortable reality: the city is sinking, with major floods occurring three times since 2002.

The Indian water dilemma goes beyond rising seas. We are also in danger of becoming a water-stressed zone. A recent water crisis in Chennai — a city of millions running dry — is symptomatic of the larger issue. The Indian government think-tank NITI Aayog estimates that 21 major Indian cities will run out of groundwater in 2020, and many more will face drinking water shortages over the next decade.

India may be among the fastest-growing economies in the world, but our per capita income is just $2,000. As we climb up the income ladder, we consume more resources. We need to manage our resource consumption well if our path is to be sustainable.

We would do well to heed lessons of history. Like India, China enjoyed rapid economic growth as it expanded its manufacturing base amid high-resource consumption. This growth came with severe environmental consequences. So the Chinese government adapted: it enacted the ‘Blue Sky’ policy and imposed stricter environmental regulations. Evidence suggests that it is working.

And China isn’t an anomaly. Governments across the globe are starting to take steps to counter climate change. To tackle air pollution, Europe has adopted stringent emission norms for passenger cars, resulting in a rapid scaling up of investments in electric vehicles. California continues to set the pace on emissions regulations, and its start-up culture is working hard to keep up.

India is implementing similar policy initiatives. The transition to Bharat Stage (BS)-VI emission norms, the equivalent to euro-VI, was fast-tracked, skipping the BS-V stage. A mix of taxation benefits, subsidies, and state fleets moving to electric vehicles has further propelled the shift toward cleaner automobiles.

Maharashtra has banned single-use plastic, Delhi adopted an odd–even plan for when private vehicles can be on the road and Karnataka closed plants around Bellandur Lake in response to rising pollution. All such policy initiatives create both risks and opportunities for Indian corporates. These businesses may have had a free ride on environmental matters, but today they ignore such issues at their peril.

Prime Minister Narendra Modi has set an ambitious goal of India becoming a $5 trillion economy by 2024 and has also made bold environmental commitments.

Fiduciary duty to the community

So what role do investors have? Historically, we’ve focused on financial performance and corporate governance to mitigate risk and assess potential for long-term value creation. That is no longer enough. Today, we owe a fiduciary duty to the community at large. Today, social and environmental concerns are at least as important as financial performance and governance. And our twin fiduciary duties – to our investors and to the larger community – are best served not by maximising short-term profitability but by concentrating on long-term returns and risks.

At SBI Funds Management, we believe that companies that focus on the triple bottom line — people, planet and profits — deliver sustained returns over an extended period. That’s why we integrated ESG factors into our investment decision-making a few years ago. This means, apart from financial considerations, we look at the environmental footprint, social impact, and governance factors of our investee companies.

The logic is simple: long-term sustainable growth requires a sustainable business and a sustainable environment. Adopting this logic creates a virtuous cycle: as investors focus on ESG, companies respond by integrating such considerations into their business practices.

Globally, this cycle is gaining momentum. Large institutional investors — pension funds and sovereign wealth funds — have embraced ESG. And as climate change’s toll grows ever steeper and harder to deny, momentum will increase further. Many institutions have divested from fossil fuels. More will follow.

But what about returns? By screening out companies based on ESG data and limiting our investment universe, could we be shortchanging our clients? While reasonable, such concerns look to be overblown. Ample and growing evidence from across the globe suggests ESG strategies deliver better-risk adjusted performance. Even in India, the NIFTY 100 ESG Index has outperformed the NIFTY 100 across time periods.

As investors, we need to answer the climate change challenge and pull up our values-based socks. The need to integrate ESG considerations into investment analysis will only grow stronger. We have no choice. We owe it to the planet. We owe it to future generations.

For more from Navneet Munot, CFA visit the Enterprising Investor and don’t forget to subscribe.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.