The Power of Responsible Profits: Mastering the ABCs of ESG Investing!

The Power of Responsible Profits: Mastering the ABCs of ESG Investing!

In recent times, there has been a gradual but steady transformation in the principles guiding investment, capturing the attention of the financial world. One of these events that has brought about a significant change in the investment landscape is the global pandemic acting as a catalyst in hastening the widespread adoption of ESG (Environmental, Social, and Governance) investing. This particular approach to investment involves carefully choosing companies to invest in based on predefined criteria related to their environmental impact, social responsibility, and corporate governance practices, all aimed at generating sustainable and well-balanced returns over the long run.

The headwinds of change and the rise of the ESG arena of investing are already palpable. The PwC Global Investor Survey 2022 states, “Investors told us that the top priority for business should be the development of innovative products, services and ways of operating (83%). Ranked second is the need to maintain profitable financial performance (69%). And environmental, social and governance (ESG) outcomes also appear among investors’ priorities for business…” According to a survey report published by Dow Jones in Sept 2022, ESG investments are projected to more than double in the next three years, accounting for 15% of all investments by 2025.

The fundamental tenets of ESG investing

Environmental:

In the present scenario, it is widely acknowledged that every business endeavour carries inherent environmental consequences. Given the pressing concerns of climate change, ecosystem degradation, and the declining quality of air and water, it becomes imperative for corporations to undertake measures that alleviate the adverse environmental effects resulting from their activities. A fundamental aspect of ESG investing revolves around supporting companies that actively strive to adopt environmentally friendly approaches and practices.

Social:

The concept of "social" in the context of companies revolves around their underlying values and principles that shape their interactions with different stakeholders in the broader ecosystem, including employees, customers, suppliers, and business partners. The objective is to identify companies that adhere to socially responsible policies, uphold ethical management practices, and prioritize the welfare of their human resources, thereby cultivating a positive work environment both internally and externally.

Governance:

The aspect of "corporate governance" serves as a framework for assessing a company's management practices, ethical standards, and its capacity to effectively handle long-term risks and opportunities. For instance, it involves evaluating whether the company maintains complete transparency in its financial reporting and if it has robust mechanisms in place to prevent bribery, corruption, or any unlawful activities. Embracing sound corporate governance practices ensures that the interests of shareholders align with those of the company, thereby fostering value creation for shareholders.

Why you should consider investing in ESG funds?

In the past, ESG investments were burdened by the perception that investors would have to sacrifice financial returns due to the limited pool of eligible companies for investment. However, this assumption is gradually being debunked. The NYU Stern Centre for Sustainable Business and Rockefeller Asset Management, collaborate to examine the relationship between ESG and financial performance in more than 1,000 research papers from 2015 – 2020. The report stated, “We found a positive relationship between ESG and financial performance for 58% of the “corporate” studies focused on operational metrics such as ROE (Return on Equity), ROA (Return on Assets), or stock price with 13% showing neutral impact, 21% mixed results (the same study finding a positive, neutral or negative results) and only 8% showing a negative relationship.” ROE is the net income divided by shareholder equity. It's a measure of profitability whereas ROA is the net income divided by total assets and indicates how well a company is using its assets.

The utilization of environmental, social, and governance criteria extends beyond mere ethical alignment between companies and investors, offering practical benefits. Through the application of ESG filters, investors can steer clear of companies whose practices might be indicative of significant troubles, which can result in a dramatic decline in stock prices and billions of dollars in losses. By incorporating ESG factors into their decision-making process, investors can effectively identify and avoid companies exhibiting warning signs.

ESG investing allows individuals to align their investments with their personal values, promoting positive social and environmental impact. By investing in companies that prioritize sustainability, ethical practices, and good governance, investors can contribute to creating a more sustainable and responsible future. Secondly, ESG funds have shown potential for delivering competitive financial returns while managing risk effectively. Research indicates that companies with strong ESG credentials tend to demonstrate resilience and long-term stability, making them attractive investment options.

ESG investing is gaining significant momentum globally and within India, with increasing support from regulators, market participants, and stakeholders. Embracing ESG funds early on provides an opportunity for novice investors to be part of this transformative shift in investment practices and capitalize on the potential growth of sustainable businesses.

An Investor education and Awareness initiative of Aditya Birla Sun Life Mutual Fund

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