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Special Report

ESG: The metrics jigsaw


India: Still early days

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The growing adoption and importance of ESG criteria among Indian firms could have implications for companies such as rice producers

Key points

  • India sees the launch of the first equity funds integrating ESG
  • One ESG leader seeks to build an ESG integration narrative in the investment sector
  • Indian companies face increased water risk

Rice growers in India might find they have to alter their farming methods in future. The crop consumes more water than alternative grains and is particularly vulnerable to droughts and floods expected from further climate change. That is the concern of Abhay Laijawala, managing director and fund manager of Avendus Capital, an asset manager with headquarters in Mumbai, India, and subsidiaries in London and New York.

Not only should rice cultivation become more efficient, but companies trading the commodity should be downgraded, he suggests, saying “we won’t invest in rice exporters”. Avendus India ESG, launched in February 2019, is among a small number of Indian funds building an equity portfolio based on integrating environment, social and governance (ESG) criteria. 

It followed a similar $1bn (€900m) ESG fund launch by another Indian fund manager, Quantum Advisors, in January 2019. SBI Magnum Equity ESG fund, a thematic fund that launched in 2018, preceded both. The trio are unusual among equity funds in India, each considering ESG criteria in different ways although they operate alongside a few overseas private investment firms also stating that they take these factors into account. In addition, a small number of equity funds domiciled in India have started to practise exclusionary policies.

With $1bn of assets under management, Avendus ESG faces an intriguing challenge as India scrambles to develop its economy. In recent years, a volatile investment market has been beset by several banking frauds affecting confidence in finance. “India has a huge non-performing asset problem in the banks,” says Bhavna Prasad, director of sustainable business at the Indian arm of NGO WWF. Governance is thus the most significant ESG concern preoccupying any investor concerned by such issues, although ESG as a badge means little in India. 

“ESG is a nascent segment. For most financial institutions, ESG consists of compliance with government regulations. Financial institutions are looking at that but have not advanced to the point of considering ESG risks or opportunities in commercial transactions,” Prasad says.

msci india annual performance

Some of the tools of analysis are already available, though, facilitating the development of the sector. In 2012, the government of India introduced a rule requiring the top 100 listed companies on the Bombay Stock Exchange and National Stock Exchange to publish annual ESG disclosures, thus encouraging evaluations of ESG performance. 

In 2017, this directive was expanded to include the top 500 listed companies. One year later, a survey by the Principles for Responsible Investment (PRI), Chartered Financial Analyst Institute and Bloomberg showed that 88.9% of the largest companies were reporting on ESG.

Meanwhile, the Indian green bond market has been growing rapidly since its first issue in 2015, and has become the second largest in Asia after China with a cumulative issuance of $6.5bn. At the same time, about $5.4bn was invested up to 2015 in India’s impact-venture investment market, which is the largest and fastest-growing in Asia, with a 14% average annual increase in capital invested in 2010-16.

India’s financial sector sees growing relevance for environmental and social factors

Financial publisher Bloomberg, the PRI and CFA Institute raised awareness of ESG in Asia through a 2017-2018 survey of financial professionals released in April 2019. 

In India, respondents considered governance the ESG factor most affecting share prices and bond yields. Two-thirds of respondents said that governance problems affected share prices in 2017, compared with less than a third for social and environmental matters. However, this rises to 61% and 55% respectively for these factors when looking ahead to 2022. Equity researchers benefit from more data than a few years ago although this contains the same flaws as in the EU and US. 

An analysis of ESG reporting among companies with market capitalisation exceeding $1bn showed 100% of companies in the energy, technology and communications sectors reporting on ESG factors, followed by about 88% in the consumer goods and financial sectors. The materials and energy sectors have been adequately covering all three ESG components, and the technology sector has been reporting comprehensively on the environment. 

Although the integration of ESG into equity funds is at an embryonic phase, Prasad draws attention to a few positive signals in the industry. “One fund announced they were investing in the Mumbai Coastal Road project. Once the firm had conducted environmental due diligence, it pulled out. This indicates how some of these firms are getting serious about such issues,” she says.

For Avendus Capital, however, water scarcity ranks high on the list of concerns alongside air quality. According to government policy thinktank NITI Aayog, serious water shortages are expected by 2025-30, and groundwater resources will diminish due to more destructive monsoons. Water stress per hectare is likely to intensify because India has 16% of the world’s population, yet only 4% of its freshwater resources and 3% of its land. Hence the country is likely to face unprecedented problems relating to water access in the coming decade, suggesting water constitutes a material risk for a rising number of companies.

That, in turn, may prompt further regulatory action. “Foreign investors will be funding companies that are compelled to do better water management,” says Laijawala. As an example, he points to a Chennai drinks company that may be about to lose its licence to operate. But he suggests it is also possible that risks for large companies such as Hindustan Unilever and Tata Steel have not been fully assessed by the market in this respect.

As a result, the ESG fund aims to make water stewardship a priority for portfolio companies. “We will engage with companies not fully dealing with their water strategy to do more. If they are doing well on water strategies we will weight them more heavily in our portfolio,” Laijawala says. The fund integrates data from ESG rankings provided by Institutional Investor Advisory Services IIAS), an independent Indian rankings adviser, creating a portfolio based on proprietary financial and ESG analysis. 

By integrating such ESG factors alongside mainstream company analysis, the fund manager intends to identify risks and opportunities that have not been fully priced in, with the objective of creating value and generating alpha as a result. In the six months since inception, the fund states it has outperformed benchmarks by 3%. It operates a long-only, low-turnover, high-conviction strategy with long-term returns from a concentrated portfolio of 15-25 high-conviction stocks. 

“While the multinational companies operating here have the necessary consciousness on water stewardship, most Indian companies are still unaware. We want to drive that change” - Abhay Laijawala

Above all, though, the management intends to make its mark as a local player championing the concept of ESG integration into the Indian equity investment market. “We want to build up the scale and the narrative on ESG and drive the impact of ESG,” says Laijawala. “Currently in India, companies are not necessarily conscious of the urgency to adopt a collective approach with every stakeholder in the water basin, for example. We have observed that while the multinational companies operating here have the necessary consciousness on water stewardship, most Indian companies are still unaware. We want to drive that change.” 

As a longer-term outcome, the company foresees the possibility that foreign investors conscious of ESG investing in India would make more impact than on ESG in more mature economies.

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