ESG trends are gaining traction now, investors need to align portfolios accordingly

ESG trends are gaining traction now, investors need to align portfolios accordingly

By Parijat Garg.

Adam Smith famously said – “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.” What was left unsaid was that the baker makes money because society at large is willing to pay for bread. In capitalistic economies, while profit maximization is the goal, it is not divorced from the demands of society. In fact, it is intricately entwined with them. And what society wants today is undergoing a massive shift. A shift towards sustainability and social responsibility. Businesses that fail to deliver on these demands face serious risks.

Decades of efforts by activists and NGOs have pushed questions of sustainability and social responsibility to the forefront of the social psyche. Whether or not they are willing to pay for it yet, consumers care for and respond to claims of sustainability. You cannot find a plastic straw at an upscale restaurant today. It is not because the restaurants care for sustainability, but because their customers do. It has gotten so that it is impossible to buy a piece of branded clothing or stay at a hotel without encountering some claim of sustainability from the brand.

Consider regulators. Starting with the National Green Tribunal in 2010 to India’s Net Zero commitment, we have already come a long way. And the momentum is only building across many dimensions of sustainability. In many ways, Chinese regulators have been very aggressive, banning the import of several types of plastics for recycling, and also shutting down several polluting industries en masse. China, with so much to lose by doing this, did it. The odds, therefore, that other regulators will follow only look higher.

What it means for investors

These tectonic shifts create incredibly large sources of risk. And given the broad spectrum of sustainability and social responsibility, no business remains untouched by these concerns. If you make steel, you must consider how much coal you are burning. If you sell soft drinks, you must be mindful of your impact on groundwater levels. If you make software, you must ensure that your workforce is diverse, and you offer a safe place to work. If you are found wanting, you can face social and regulatory backlash that can take a heavy toll on your business.

On the flip side, there is a great sea of opportunities also opening up. From organic foods to electric vehicles, entirely new markets are coming alive. Even the prevailing industries are facing a reordering. From fast fashion to fast food, customers are being wooed by promises of sustainable products and socially responsible practices.

As investors, it is almost irresponsible to ignore these forces. With consumer preferences and regulatory actions increasingly being driven by questions of sustainability, does it make sense to silo these considerations to narrowly defined “ESG portfolios”? Would you ignore government capital expenditure plans when analyzing infrastructure companies? Or the demographic changes leading to greater demand for denim jeans vs sarees? Then why would you ignore demands for sustainability?

ESG investing may have started as a means for some investors to ensure their money does not help socially damaging businesses. But that was a long time ago. ESG is now a force that affects every business and every investment. We must all be ESG investors now. We ignore it at our own peril.

(Parijat Garg is a Fund Manager and Senior VP at IIFL AMC. Views expressed are the author’s own. Please consult your financial advisor before investing.)