Quantum AMC has launched an ESG fund.
I V SUBRAMANIAM, Managing Director, CEO and CIO of Quantum Advisors, discusses the hunt for stocks that are in sync with Environmental, Social and Governance (ESG) factors.
How different are ESG funds from ethical funds?
Ethical funds follow an exclusion list which screen out companies where they will not invest. On the other hand, ESG funds have a wider theme. It’s a positive list as opposed to a negative list. The scope to invest is much wider in ESG. We can pick and choose how we want to construct the portfolio.
Ethical funds have not had many takers. Why would ESG funds catch on?
The awareness among investors is increasing. They may experiment with a smaller allocation to this fund. In the current scenario - auditors resigning, companies defaulting on repayments, governance issues surfacing - investments cannot be done blindly. The acceptability of the ESG factor is high, though converting into actual investment may take some time.
How many companies in India fit the ESG criteria?
All types of listed companies will fit the ESG criteria. However, not all companies disclose the information required to evaluate on ESG factors. The top 100 companies by market capitalization share a lot of data related to ESG. The next 100 companies give less information, but they are improving. The bottom most companies by market capitalization are not sharing much information. But as promoters realize that markets tend to give higher valuation to companies which have higher disclosures, I think those metrics will change and the investment universe for ESG will become larger.
Name some filters for screening ESG companies.
We would look at water consumption, energy consumption, corporate governance, independent directors, child labour, how do they treat staff, etc.
We will look at look at carbon norms, emission norms, water consumption, waste recyclable practices, energy practices, etc. We will understand the business. How they manufacture products. Do they cause pollution during the manufacturing process? If they are causing pollution, how are they trying to reduce it. For instance, companies like NTPC cause pollution. But the company is taking steps to reduce pollution. Five years later, this could be a completely different company.
Based on the score and weights, we get an overall ESG score. SEBI is also nudging companies to publish a Business Responsibility Report which is mandatory for the top 500 companies from this year. From next year, it will be mandatory for the top 1,000 companies. So more information is coming out.
How difficult is to glean this information?
It is not easy. Thus, it is important to have your own resources to gather such information. Our team visits factories, meets suppliers, meets the management to understand qualitative factors. For instance, Titan has done a phenomenal job to ensure that labour practices are good. The stock’s Price to Equity (P/E) valuation compared to its peers is much higher.
Do you think companies can engage in window-dressing to qualify to become ESG compliant?
There will be some companies which will do that. To spot such companies, research analysts have to dig deeper.
Why do family owned business score low on ESG?
From a governance perspective we need to look at whether the family has all the skill sets to run the business. If family members don’t have the skills and still make it to the top position in the company, then it is a question mark on governance. Thus, we always do higher due diligence on family owned businesses. A lot of times, the talent could be outside the family. The business should bring in that talent. For instance, Marico is a family owned firm, but it has brought in external professional talent to run the business.
To what extent do your existing equity funds follow ESG principles?
Our existing funds have always given importance to ESG factors. Lately, we have started focusing on governance as well. Over and above ESG, we also have valuation criteria in our existing funds. Quantum Long Term Equity Fund looks at ESG and valuations too.
However, the new ESG focused fund will not assign much importance to valuations. The fund will invest in companies with high ESG score even if their valuations are high.
In the long run, do you think companies scoring high on ESG could generate better returns in comparison with companies which have low ESG score?
I think they will do well. One of the key factors in any company is sustainability of business in the long run. If they score high on ESG, then we think their businesses are sustainable. Slowly, the market will also start to recognize that, which will get reflected in valuations.
If data on ESG qualified stocks are readily available and if ESG funds grow in popularity and size, will generating alpha become a challenge since ESG factor can be already priced in the stocks?
There is a lot of data available on companies for regular mutual funds. Similarly, ESG data disclosure will also improve going ahead. How you interpret that information will be the key to arrive at a decision. Managers who will be able to interpret the data better will generate alpha.
Globally, a lot of passive ESG strategies are available. What kind of strategy (passive versus active) will work in India when it comes to ESG?
Active ESG funds will perform better than passive. In passive, the only problem is the index. When we look at the current ESG indices, we wonder whether some of the companies which form part of the indices fit ESG criteria. So fund managers have to be careful and not blindly invest in the constituents of the ESG index.
So your fund will take bets outside the benchmark - NIFTY100 ESG Index.
We are index agnostic.
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