The above graph says it all. After a 15month hiccup from its Jan-08 launch(where it performed same as other indices), it broke away in Apr-09, and has not looked back since. A nearly 2.5yr track record of out-performance is not a joke. Now, one may argue that it was lucky to exclude under-performing sectors like PSU banks etc, but still that speaks for the strength of the selection process. Surprisingly, Shariah indices underperformed their broader counterparts despite excluding the poorly performing financial services sector.
The methodology document claims that "It is an index based purely on quantitative factors rather than subjective ones. For the first time, environmental, social and corporate governing factors have been extensively quantified and translated into a series of scores measuring securities in the universe of publicly traded Indian companies. This index not only ensures a selection of environmentally, socially and corporate governance responsible companies, but also securities which are representative of the Indian equity markets based on size and liquidity"
The measures certainly seem exhaustive but on closer scrutiny do not stand up to sustained scrutiny. For instance, the data sought in the initial template for corporate governance is largely boilerplate. The few distinguishing factors are remuneration, rationale for independent directors etc. But otherwise, do they really expect companies to disclose details on corruption/business ethics? And if they do, are they rewarding companies who hire PR agencies like Trisys to publish glossy annual reports with plenty of irrelevant disclosures, but with little information otherwise? But, the data sought for the environment/social conduct does seem more differentiating, because very few companies have disclosed these things in the reports I've seen. Things like anti trust, quality, product safety and pollution hardly exists in the lexicon of companies. And they disclose stuff like labour relations etc because that is mandatory in the annual report.
There is potential to to improve the factors by adding stuff like independent directors, special resolutions passed, audit qualifications, sustainability report publishing etc. But then, that would become too subjective. And then,150 companies with the highest scores under the initial process are selected for the qualitative process, whose score(1-5) is summed with initial core to yield final result. So while some unworthy candidates may clear the initial round, they are unlikely to pass the qualitative round.
Conclusion-While all the quantitative scoring factors are part of mandatory disclosures/not totally relevant for ESG investing, they seem to work. So like the late Chairman Deng, I shall not bother about the colour of the ESG index, as long as it continues to outperform. Do investors in Indian equities really care, or are the factors correlated with superior performance? Or is it survivor-ship bias? I leave these questions for you to ponder on, the factors used in the methodology, are copied below
Template for Assessing Conduct on Governance of Indian Companies
Ownership Structure and Shareholder Rights • Shareholder Capital • Shareholder Rights
Financial and Operational Information • Financial Information • Operational Information
Board and Management Structure and Process • Board and Management Information
• Board and Management Remuneration
Business Ethics and Corporate Responsibility • Corporate Governance • Corruption
• Leadership • Business Ethics
Template for Assessing Environment and Social Conduct (E& S) of Indian Companies
Environment • Environmental Pollution • Natural Resources Use
Management Policy and Performance Indicators Employees • Employee Relations/Job Creation
• Labor Rights • Equal Opportunity • Union Relations
Community • Human Rights • Community Investment
Customers/Product • Product Safety • Anti-trust • Customer Outreach and Product Quality