ESG theme for stocks to accelerate in 2022

“It is estimated that more than $40 trillion—or more than 25%—of all professionally managed assets globally have some level of environmental, social and governance (ESG) theme overlay in the investment process. This number and percentage of assets are only expected to grow in 2022 and beyond. This trend is relatively nascent in India, but is becoming increasingly important for investors in the Indian equity market as well,” said Vikram Gandhi, senior lecturer of business administration at the Harvard Business School, and founder of Asha Impact.

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India is in the early stages of its ESG journey. At the UN Climate Change Conference (COP26), India said it intends to achieve net zero in carbon emissions by 2070. “This is likely to help us get much better marks on the ESG aspect compared with our peers such as China and Russia,” Kotak Mahindra Asset Management Co. Ltd said last month.

The focus on sustainable investing among equity market participants is expected to rise with more companies and countries implementing policies to meet ESG targets, particularly with respect to carbon emissions. “ESG will be an important driver of investment decisions this year, especially in the Asia Pacific region. Currently, most Asian investors are using an exclusion-based ESG screening, which excludes stocks with adverse ESG credentials. We think Asian investors will soon embrace impact-based ESG screening as reporting standards improve across the region,” said Girish Nair, co-head Asia Pacific, ESG research, BofA Securities.

Recent research by BofA Securities showed that Asia emits 52% of global carbon emissions. In the last ten years, Asia has enacted close to 262 policies, compared to just 34 in the US and 543 in Europe, pointed out BofA research.

In India, ESG has seen higher traction in the past year. Companies, including Reliance Industries Ltd, Ultratech Cement Ltd and Hindalco Industries Ltd, are investing in green energy and aim to cut their carbon footprint. In recent years, many asset management companies launched ESG-focused mutual fund schemes in India.

However, there are challenges because of the lack of standardization of reporting. On average, just 5% of stocks in Asia report metrics on emissions compared with 66% in the US and 78% in Europe, showed BofA’s research. Globally, market regulators are addressing the lack of standardization through policy implementation. In Europe, the Sustainable Finance Disclosure Regulation makes it mandatory for companies to make ESG disclosures. In India, the top 1,000 listed companies by market cap will have to mandatorily file the Business Responsibility and Sustainability Report (BRSR) from FY23. BRSR is aimed at ensuring quantitative and standardized disclosures on ESG parameters, facilitating comparability across industries and should enable people to make better investment decisions. How efficiently companies are able to meet their ESG targets and the reporting standards remains to be seen. Making one’s business model sustainable requires investments in new technologies or manufacturing processes, which could weigh on near-term operating cash flows and profits. However, the stock markets are likely to reward such moves.

Stocks in Asia with high ESG scores on the MSCI are trading at a 40% premium to stocks with low ESG scores, according to Nair’s analysis. “We have seen similar valuation premiums in other parts of the world, including the US and Europe,” he said.