Firms with green, social focus fetch better returns

Firms that focus on managing their environmental, social, and governance risks have given better returns than others that rank lower on these. 

The Morningstar India Sustainability Index, which tracks the performance of Indian companies that exhibit high ESG (environmental, social, and governance) levels, has returned 14.8 per cent in the four-year period between October 2012 and September 2016 compared with 13.7 per cent for the Morningstar India Index. 

The index is derived from large-capitalisation and mid-capitalisation subsets of the Morningstar India Index, representing 90 per cent of market capitalisation. The top five constituents of the index are HDFC, representing 10 per cent of the gauge; Reliance Industries 9 per cent; Tata Consultancy Services 8.1 per cent, Infosys 8 per cent; and Hindustan Unilever Limited 4.7 per cent). 

"There is a general perception that sustainable investing is only for investors who care about ESG issues and not financial outcome. That is not true as sustainable investing does not come with a cost," said Sivananth Ramachandran, manager, new product development, indexes, Morningstar India. "This is an evolving concept in India and its importance will increase in the coming years," he adds. 

The 500 largest Indian companies by market capitalisation are required to issue an annual report based on social, environmental, and economic responsibilities taken in line with national voluntary guidelines. In addition, the law requires large companies (including foreign multinationals doing business in India) to earmark two per cent of their average trailing three-year profits to corporate social responsibility.

The technology sector is the driver of the country's strong overall sustainability score. The sector, the second-largest on the index at 14 per cent of float-adjusted market capitalisation, has a score of 74.7 per cent compared to 49.2 per cent for energy and consumer sectors, 48.2 per cent for industrials, 43.6 per cent for financial services, and 38.8 per cent for health-care firms.

Tech firms are handling key ESG issues well in areas such as human capital, data privacy and security, energy use and greenhouse gas emissions, and anti-bribery and corruption practices. "With an overwhelming majority of their revenues coming from Europe and the United States, many of these firms' clients have supplier standards that Indian companies must follow to win and retain their business," said a Morningstar report.

Health-care firms, which had the lowest-weighted average ESG score, score poorly relative to their global and emerging-markets peers on Sustainalytics' product quality and safety indicators. In recent years, large drug companies such as Sun Pharmaceutical, Wockhardt, Lupin, and Ipca Laboratories have faced US Food and Drug Administration warnings and, more seriously, US ban on products from several of their factories.

Low scores for financial services are driven primarily by banks. "The financial-services sector performs poorly in two areas: Responsible finance and business ethics. Indian financial institutions have also been slow to adopt global best practices to ease social and environmental impacts of their lending and investment decisions," said the report. 

There are more than $21.4 trillion in global assets invested sustainably, according to Morningstar. According to the CFA Institute, evaluating ESG issues "will likely lead to more complete investment analyses and better-informed investment decisions".

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