The pricing and market return of businesses now reflect their sustainability practices. The scarcity of resources has prompted businesses to adopt a more efficient and strategic approach to resource utilisation. This prudent resource management has heightened the significance of corporate social responsibility (CSR) and sustainability practices in today's context. Firms with a long-term survival goal prioritise achieving sustainable development objectives.
The adoption of Environmental, Social, and Governance principles is not exclusive to developed economies; emerging markets like India are actively embracing this trend. The World Economic Forum's 2022 report reveals India's commitment to achieving net zero emissions by 2070 and a 50% share of renewable energy by 2030. Realising such ambitious targets necessitates companies adopting inclusive ESG practices.
Waddock and Graves (1997) explore the intersection between a company's social and financial performance, emphasising the strategic and efficient use of resources. Notably, accomplishments related to Sustainable Development Goals (SDGs) and Environmental, Social, and Governance (ESG) parameters are now factored into market returns, leading to the development of separate ESG-based indices in numerous economies.
Traditionally, businesses focused on profit-oriented operations, but if ESG activities prove to be profitable, the effective implementation of SDGs becomes feasible.
Consequently, researchers find interest in analysing indexes comprising companies based on ESG parameters. This study ‘Does ESG risk management ensure better risk management?’ by Swati Sharma delves into the performance of two such indexes: NIFTY 100 Enhanced ESG and NIFTY 100 Sector Leaders Index, both grounded in robust ESG risk management.
Insights from India
In the Indian context, the National Stock Exchange (NSE) has introduced three such indices—NIFTY 100 ESG Index, NIFTY 100 Enhanced ESG Index, and NIFTY 100 ESG Sector Leader Index. These indices comprise companies selected based on their ESG parameters, drawing considerable attention from researchers.
This study delves into the analysis of two Indian ESG-based indices—the NIFTY 100 Enhanced ESG index and Nifty100 ESG Sector Leaders Index. These indices gauge the performance of companies within the NIFTY100 index based on their ESG scores. The NIFTY 100 Enhanced ESG index assembles a portfolio with sector exposure akin to Nifty 100, albeit with superior-performing ESG stocks.
In contrast, the Nifty100 ESG Sector Leaders Index comprises selected companies based on their ESG risk management within each sector of the Nifty100. Both indices deliberately exclude companies entangled in significant environmental, social, or governance controversies, emphasising their foundation on better-performing ESG risk stocks. However, despite their significance, the performances of these indices have not been thoroughly explored in existing literature.
This study aims to fill this gap by scrutinising the performance of these ESG-based indices, shedding light on the interplay between general risk management and ESG risk management. Employing various Value at Risk (VaR) methods, the study models risk and utilises VaR calculations to profile risk for investors.
The integration of results from index performance and VaR calculations provides a comprehensive evaluation of the indices. The study is structured into four sections: an introduction, research methodology, data analysis and findings, and a discussion on the scope and implications before concluding remarks.
Research methodology
The study analyses daily closing prices from January 2021 to December 2022, capturing the recent post-pandemic market impact. Descriptive statistics reveal non-normal distribution in index prices. Return series are derived for further analysis, considering non-normality, stationarity, and serial correlation. Value at Risk (VaR) models are employed to assess index performance, integrating results for a comprehensive evaluation. The analysis explores index returns and employs Value at Risk (VaR) calculations to predict post-COVID returns.
Data analysis and findings
Stationarity tests confirm the reliability of return series data. Employing ARMA-EGARCH models for VaR, the study suggests exploring alternative models and employing two-stage conditional EVT VaR for return forecasts. The study recommends additional tests, such as independence and conditional coverage, to enhance VaR model robustness. Further research could compare indices globally and explore sustainability indices from various countries.
The study suggests employing alternative VaR models and exploring two-stage conditional EVT VaR. Limitations of unconditional coverage tests are acknowledged, advocating for additional tests proposed by Christoffersen. Comparative studies on global indices and sustainability indices can offer deeper insights. The study concludes that specialised ESG indexes perform well, affirming their positive correlation with overall risk management. It emphasises the need for a clear public policy on ESG investing in India for ongoing business activities.
Specialised ESG indexes exhibit superior performance, with robust back-testing results at a 99% confidence level. This underscores the market's efficiency in absorbing shocks. The study concludes a positive correlation between ESG risk management and overall risk management, advocating for sustainable finance as common business practice.
Analysis of NIFTY 100 Enhanced ESG and NIFTY 100 Sector Leader indexes supports the financial incentive for ESG investing practices. A call for clear public policy on ESG investing in India is emphasised, recognising the immediacy of energy efficiency and clean energy investments.
Conclusion
The findings of the study conclude that both specialised ESG indexes have performed better. The back-testing result suggests that, at a higher level of confidence, i.e., 99%, tested VaR models are robust. Such results also indicate the market's ability to absorb the shock efficiently. This study also indicates that there is low risk and positive performance for indexes, which consist of stocks based on their ESG activities.
Hence, it can be concluded that the stocks that have a higher score for managing ESG risks are performing better overall. This study also proposes that there is a positive correlation between ESG risk management and overall risk management. The findings of the present study also advocate the need to include sustainable finance as a common business practice for enhanced performance of index and stocks. NIFTY 100 Enhanced ESG Index and NIFTY100 Sector Leader Index performance analysis confirms that financial incentives to include ESG investing practices by companies exist.
Comparative studies and further exploration of the data will provide more insight into such index performance. Lastly, this study emphasises having a clear public policy for ESG investing in India because energy efficiency and clean energy investment are not future but present business activities.
The full paper can be accessed here
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