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Why companies in India are increasing their focus on sustainability

By Vinay Agarwal, director and portfolio manager at FSSA Investment Managers, part of First Sentier Investors.

In our view, several factors make India an attractive market to invest in over the long term. Firstly, the majority of listed companies are privately owned rather than being state owned. As minority shareholders, we find it easier to feel aligned with private owners who don’t have the national service obligations of state-owned companies. Secondly, most sectors in India are significantly under-penetrated. Even the market leaders in these sectors are relatively small in size. These leaders have a long runway of growth ahead of them as penetration rises. Management teams are also conscious of the need to earn high returns on capital due to the high cost and historical scarcity of capital. As we also constantly engage with management teams across markets, we find that managers here are always willing to learn. They are keen to engage with all stakeholders to improve their business franchise and their governance standards. For these reasons, we believe India offers a much larger universe of high quality, investible companies than other regional markets.

A misconception about the attractiveness of India’s investment universe arises from the appearance that, from a top-down perspective, India always seems to be in chaos. There are diverse political interests perpetually in a tug-of-war, geopolitical issues and economic disruptions. However, from a bottom-up investor’s perspective, we have observed that leading Indian businesses have thrived despite these challenges. Over the last two decades, there have been several disruptions in India. This includes droughts, the global financial crisis, several corruption scandals leading to a change in government, demonetisation and the introduction of a new tax regime, a crisis among non-bank finance companies and, most recently, COVID-19. The top Indian companies have only become stronger during this period as they have gained market share from their weaker competitors and consistently grown profits. As the economic environment improves after the pandemic, these companies have the potential for exceptionally strong earnings growth for years to come.

Increasing adoption of ESG standards

As the Indian economy has grown significantly in recent decades, the social license to operate for businesses across sectors has become more critical. This encompasses a range of issues, from the environmental impact of their businesses to their relationship with their labour force and the role they play in their communities. We have observed that companies in India are increasingly realising that without this social license to operate, their businesses are not sustainable over the long term. The improvement in ESG standards is being driven by several stakeholders. These include:

  • Generational change within promoter families: A new generation of owners with global exposure have taken on leadership roles in many family-owned businesses. This generation of owners has studied abroad or worked at global firms. They have introduced best practices in their companies using their learnings from developed markets.
  • Regulatory changes: Mechanisms to protect the interests of minority shareholders have been strengthened consistently. Minorities have the right to reject certain related party transactions and a compulsory reverse-bidding process is required for the privatisation of a listed company. Governance standards have also improved significantly after regulations were introduced mandating a minimum level of female representation on a company’s board, periodic auditor rotation and increased disclosure levels.
  • Owners have also witnessed that, in recent years, some of the largest business groups which had a poor reputation for corporate governance have failed to survive. They are aware that they need to consistently improve their environmental, social and governance standards to ensure the sustainability of their business over the long term.

We have observed that most Indian companies intend to treat all stakeholders fairly. However, they are often unaware of best practices. This is especially the case with small and mid-sized companies, which may not have much global exposure.

Management teams are keen to engage and learn about how they can improve the sustainability of their business. For example, several Indian consumer goods businesses are dealing with the issue of environmentally harmful plastic packaging. We introduced a global bio-degradable plastic packaging solutions provider to a leading domestic consumer staples company in India. The company has started a pilot program and is currently in the process of obtaining regulatory approvals before adopting these solutions on a larger scale.

Similarly, our engagement on a range of issues from reducing water consumption to using more sustainable raw materials has been well received by management teams. They have shown a willingness to adopt effective solutions.

Markers of a high-quality company

The pandemic has provided an unprecedented opportunity for investors to identify high quality companies. By looking at whether a company’s management treats all of its stakeholders equally, we can distinguish the good companies from the others. Stakeholders are not just the majority shareholders, but also minority shareholders, employees, the tax authorities, local communities and the environment. Organisations that have shown they proactively take care of their stakeholders during difficult times have sent a reassuring message.

We like companies run by management teams who are market leaders in under-penetrated categories with significant growth potential, earn high returns on capital employed and which have demonstrated a strong track record of consistently gaining market share.

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