ESG label has loopholes, look at Quant ESG Fund

Rating agencies weren’t impressed either. For instance, Morningstar gave the fund a ‘below-average’ ESG rating, the lowest rating in that category. The remaining seven schemes by other funds in the same category were assigned either a ‘high’ or ‘above average’ rating.

Morgan Stanley Composite Index (MSCI) also put Quant’s ESG fund among the lowest-rated funds in the sustainability category. The global rating agency assigned Quant ESG ‘BBB’ rating. All five other funds except Kotak ESG Opportunities Fund and SBI Magnum ESG fund were given an ‘A’ rating.

Yet, Quant’s low ESG ratings did not seem to bother investors at all. And so, assets under management (AUM) of Quant ESG went up more than 12 times from ₹14 crore to ₹165 crore since its inception in 2020.

Quant ESG’s problem was not confined to ratings alone. Some of the stocks selected by the fund were questionable. Adani Enterprises, a stock that was largely responsible for the fund’s outperformance, has not been in the good books of ESG rating agencies. Sustainalytics calls the company ‘high risk’ and ranked it last in the ‘traders and distributors’ category. MSCI assigned the stock ‘laggard’ status and pushed it to the bottom of that category, and Crisil gave it a ‘below average’ rating’.

According to Fisdom research, Quant MF and Surat-based NJ Mutual Fund were the only asset management companies (AMCs) that had a sizeable allocation to Adani group stocks as of December 2022, before the Hindenburg report on the group unleashed a storm in the Indian markets. Many institutional investors avoided Adani group stocks, citing a lack of transparency. Quant ESG Fund, too, exited Adani Enterprises in August 2022.

To be sure, the perception of a good ESG company can vary. The ambiguity arises when there is no single authority or formula to decide which companies are socially conscious and which are not. This has resulted in many rating agencies giving opposite ratings to the same company.

For instance, Refinifitiv has ranked Reliance Industries Ltd (RIL) among the top 3 companies out of 204 firms in the ‘oil and gas’ sector, whereas Sustainalytics has classified it under ‘severe risk’, the lowest rung.

MSCI calls Asian Paints a ‘leader’ in ESG but Sustainalytics sees the paints firm as ‘high risk’. MSCI also tagged Adani Ports a ‘laggard’ , the worst in the ESG category, while Sustainalytics ranked it one of the best in the world.

Quant’s investment strategy?

The scheme information document (SID) explaining Quant ESG’s investment strategy gives little clarity on how the fund house filters stocks. It mentions that the focus will be on “the longer term impact of ESG issues rather than unduly weighting factors currently occupying market attention.”

This statement, however, does not explain the fund’s high churn rate. Quant ESG’s turnover ratio is 258% whereas the average turnover ratio in the category (excluding Quant ESG) is just 26%. Invesco India ESG fund has the second highest turnover ratio of 41%. Ideally, to reap the benefits of long-term ESG factors, fund managers hold stocks for a longer period and avoid frequent churning.

There is more to it than meets the eye. Mint found that the contents of the section ‘What are the investment strategies?’ in Quant’s SID are exactly the same as that of Axis ESG fund. But, despite having the same strategy, both the schemes have an overlap of just about 10%. Axis’s churn rate is a mere 24%. Strangely, for two funds that claim to follow the same framework for stock selection, they have two drastically different ways of deploying investor money.

The SID also states that “the investment strategy of the scheme will be to invest in a basket of securities based on combining existing traditional fundamental, bottom-up financial analysis along with a rigorous analysis on the environmental, social and governance aspects of the company.”

This statement rings alarm bells since the use of words like ‘traditional fundamental, bottom-up financial analysis’ is in stark contrast with Quant AMC’s claims on managing investments. For starters, Quant AMC is not the typical fund house that invests using fundamental analysis. Instead, it relies on VLRT, a complex data-driven framework, to buy and sell stocks. It reportedly spent more than ₹180 crore on collecting data.

Mint also found that Quant AMC did not mention the VLRT framework anywhere in the SID of its ESG portfolio whereas it was for the remaining 12 equity schemes they run. Surprisingly, no holding in the ESG portfolio is unique, meaning other schemes run by them have the same stocks. So, RIL is a recurring theme in all its MF schemes. In fact, all stocks represented in Quant ESG funds have allocation in its other MF schemes, showing a convergence in the way stocks are selected.

Quant Mutual Fund did not respond to a questionnaire sent by Mint till press time.

Nirav Karkera, head of research at Fisdom, said that Quant is looking at ESG from a very different perspective than what is generally accepted by most other mutual funds. “Along with a differentiated perspective, the ESG fund is also managed with relatively higher agility. Such agility is visible across other portfolios as well. In line with most of its funds, even the ESG fund exhibits a relatively higher churn,” said Karkera. This could have led to its outperformance but one must take a closer look at the fund house’s perception of ESG and if it still aligns with what an investor seeks from ESG-focused fund, he added.

While the ratings assigned to the fund is dismal, there is no real gold standard in terms of ESG norms, especially in the Indian context. International rating agencies’ methodology may not be directly applicable to Indian companies considering the difference in operating and regulatory environment, in ESG context specifically.

Investor safety

ESG investing is getting increasingly popular in the country and there is pressure on the market regulator to avoid ESG mutual funds from turning into a marketing gimmick. In recent times, responsible investing has gained momentum and, notably, seven of the 10 ESG mutual funds were launched in just the past three years.

Subsequently, the securities exchange board of India (Sebi) came out with consultation reports on three fronts: ESG disclosures, ratings, and investing.

On ESG investing, Sebi has proposed stricter disclosure norms to ensure that mutual funds are staying true to their tag. The regulator has sought clarity on the kind of ESG strategy the fund is following, reasonable assurance from a third party as to whether the fund is following its stated strategy, adhering to disclosure on votes cast on company resolutions, and is maintaining case studies on portfolio companies, among others .

Further, Sebi has proposed five sub-categories for ESG fund management. This means AMCs would be allowed to launch multiple ESG schemes following different strategies if the proposals become law.

Also, fund managers would be required to explain the fund’s ESG strategy on an annual basis, how they engage with holding companies, escalations raised by the fund manager to companies, and specific comments on the underlying companies.

Sebi is trying to nudge ESG rating providers (ERPs) to consider the domestic context while rating companies. For this, they will need a unique set of metrics that can be measured in the Indian context.

Sebi is also trying to improve the quality of data coming from corporates. Among other things, Sebi wants to uncover the ESG practices of a company’s supply chain participants and make audited disclosure for a set of ESG metrics mandatory. This will be implemented in a phased manner, starting with the top 1,000 companies based on market capitalization.

Till such time though, many fund managers will consider ESG to be just another trick to lure investors in the name of responsible investing. Many fund managers also argue that socially responsible filters can be applied to existing funds and that there is no need to create a separate ESG fund.

Updated: 29 Jun 2023, 09:00 AM IST