India and the ESG Challenge

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

The forest fires burning throughout the Amazon may have generated the headlines, but they are only a small sample of what is a global phenomenon. From Siberia to Canada, these conflagrations are becoming the new normal. And there are other worrisome signs, from melting glaciers to collapsing ice sheets, that demonstrate the planet’s climatic conditions have worsened considerably over the last few years.

Climate change is for real, and in India, our challenge is particularly grave. The current and previous monsoon seasons may have been normal, or close to normal, but such categorizations don’t reflect the floods in Kerala and the mountain states or the droughts in Karnataka, parts of Maharashtra, and Tamil Nadu all happening simultaneously.

Nine of the ten most-polluted cities in the world are Indian. We are also among the top three nations when it comes to 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 like Mumbai and Chennai would still be at risk from rising sea levels.

And India isn’t alone in South Asia. Indonesia’s president, Joko Widodo, has already 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. The 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. Add to that soil degradation and increased ocean acidification, and the challenge looms ever larger.

For a developing, democratic nation like ours, one that suffers from poor literacy, weak human development, and rising inequality, we have to ask whether businesses in India will continue to enjoy the access to water resources that they have today.

Indeed, 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 we are to make the path we are on a sustainable one.

We would do well to heed the 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. And evidence suggests that it is working.

And China isn’t an anomaly. Governments across the globe are starting to pay attention and 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 startup culture is working hard to keep up.

India is implementing similar policy initiatives. The transition to 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.

In other areas, 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. In Tamil Nadu, a large industrial plant was shut down because of environmental concerns. All such policy initiatives create both risks and opportunities for Indian corporates. These businesses may have had a free ride on environmental matters in the past, but today they ignore such issues at their own peril.

Prime Minister Narendra Modi has set an ambitious goal of India becoming a $5 trillion economy by 2024 and has also made bold commitments on the environmental protection front to the global community.

So what role do investors have to play? Historically, we’ve focused on financial performance and corporate governance to mitigate risk and assess the 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 maximizing short-term profitability but by concentrating on returns and risks over the long term.

At SBI Funds Management, as part of our fiduciary responsibility, value system, and risk-management strategy, it is our core belief that a business run in the best interests of all stakeholders seldom fails to create lasting value for its investors. 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 process 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. We did not wait for our investors to ask us to take up the ESG mantle. We knew it was only a matter of time before they did.

The logic behind all this 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, this momentum will increase further. Many institutions have already 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. 

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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.

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