Firms finding it hard to balance ESG with profits, says Eugene Fama

Companies across the world are finding it difficult to balance environmental, social and governance (ESG)-focused investing with profitability, and regulators too aren’t thinking hard about it, said Eugene Fama, the 2013 Nobel Prize winning economist.

“People are willing to pay more for products that are environmentally sustainable. There are ESG goals and profitability goals. I hope ESG products and profitability are compatible. I don’t think regulators are thinking enough about this either,” said professor Fama at the annual RH Patil memorial dialogue on Tuesday.

Fama, known for his empirical work on portfolio theory, asset pricing, and the efficient-market hypothesis, was speaking to Uday Kotak, managing director and CEO of Kotak Mahindra Bank. Kotak agreed that there is a “fundamental dichotomy between returns and ESG”.

According to Fama, low-cost index funds are inherently better than managed funds, as markets are efficient. “It’s not only better, but it’s also cheaper,” the Nobel Laureate said, adding that a small investor should just go with the market.

Fama, who used computers for his studies back in 1962, when very few had even seen one, does not believe that artificial intelligence (AI)-led trading will eliminate human trading.

“I don’t think the patterns that AI can bring about are just there. Markets are efficient, they adjust …” said the professor, who teaches at the University of Chicago Booth School of Business.

Finance, as a business, will continue. “Markets are always changing, basically finance will keep going,” Fama said.

However, Fama did not want to hazard a guess on whether the stock markets or tech stocks are in a bubble. “You don’t see bubbles coming, you see them going. Bubbles are always in hindsight,” Fama said.

Unlike equities, it is easier to apply efficient markets hypothesis for fixed income as the cash flows are predictable, particularly in case of government bonds, Fama said. However, it is difficult in case of corporate bonds because of the lack of liquidity.

Fama also praised emerging markets for adopting modern trading mechanisms. These emerging markets witness heavy trading, and the volatility “is really high.”

According to Kotak, India has extremely efficient equity markets and ranks in the top four in terms of volume. India also has much greater liquidity in the markets than many established markets, Kotak said.

The economy is looking much better in October and November than in April or May, and there is much greater efficiency and productivity in the organised sector, Kotak said.

“Significant reduction in interest rate is making the core discount rate much lower, and assets are adjusting to lower discount rate,” Kotak said. Retail investors taking interest is a good sign for the economy, but they should be careful about leverage. “There should not be any hubris or exuberance, even as we get to know about bubbles only with the hindsight, as professor Fama mentioned,” said Kotak.

Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd