The COP26 brings parties together to accelerate action towards the climate agreement and the other UN goals around climate change. In the lead up to the event, Starlene Sharma, Consulting Editor, spoke with Ajit Dayal founder of Quantum Advisors on how to make climate finance smart and available to solve this greatest problem of our lifetime. Edited excerpts
Quantum was a first adopter of ESG as an investment class in India. What was the motivation for this and how has this journey evolved?
When I started Quantum in 1990, this was 18 months before the big economic reforms under then finance minister, Manmohan Singh of July 1991. I had a joint venture with Jardine Fleming, the first joint venture between a foreign group and a local group. But I left this extremely successful joint venture in December 1995, about three years after setting it up. Because I came across certain practices by Indian companies which I did not like. I sold those shares and in the process, the family of that company called up the Chairman of Flemings and asked, “Why are you guys selling our shares?” And they asked me why am I selling? I said I’ve got a problem with the governance and minority shareholder protection.
Jardine was not happy that I was selling shares because there was a lot of business to be had from that one company. And so I left and set up Quantum and in January 1996 we created an Integrity Screen. A very naive and innocent form of what we call ESG today. It’s been 25 years that we haven’t held shares of companies whose founders are a combination of Yukos, WorldCom and Enron – all rolled in one. We’ve lost a lot of price return, but we’ve had fabulous restful sleepful nights in the process, and made money for our clients. We’ve had it for the last 25 years and the Integrity Screen in 1996 morphed into a robust and structured ESG process in 2015.
With COP26 around the corner what are your views on climate, environment and the role they play in your portfolio?
We are not scientists. We listen, we assess, and then act or take a view once we understand. There was a company called South India Viscose in the Jardine Fleming/Quantum joint venture days. We raised capital for them, but bad luck that six weeks after they had a spill at their plant which polluted the river and hurt people downstream. The end result was that the local state government turned shareholder and auctioned off the plant, pretty much for free. The only condition was that the new buyer would have to clean up the plant, the river, the land.
As recently as March 2019 we had a difference of opinion. We were shareholders, I think the sixth- or seventh-largest shareholder in India’s largest construction company, Larsen and Toubro. And they were contractors for the Mumbai Municipal Corporation on building a coastal road. We had a lot of questions about the environmental sustainability of the coastal road. Mumbai is at sea level, many parts of Mumbai are below sea level. And as we’ve been reading by the year 2050, 2075 sea levels are expected to rise.
So was the building of a coastal road going to create a structure that would encourage flooding in the city? We asked if they had done an environmental study and they said, no, we haven’t, but the client had done one. We said that’s not good enough. The client is the Municipal Corporation. If something goes wrong, you as the construction company will be sued by investors. And the CEO will retire, the chairman will retire. And we, as long-term investors, will be left holding the bag and paying all fines and fees.
In January 2019, a company in Brazil called Vale had a dam break and all the sludge in the dam killed about a few hundred people downstream. And they lost 25 per cent of market cap, about $3 billion of market cap in a week as they got sued in the courts of New York. So we used that example but they didn’t seem to care. We do worry about climate change. We do worry about the environment. We’re not scientists, but we’d like to hear and see what companies are doing about it, what the consultants are advising them to do. We don’t want to invest in a company that’s about to get sued or has sports by the waterfront and doesn’t care about what may happen with higher rising sea levels. We think of it more as a risk mitigation exercise without being fanatical about it.
Given your early adoption with ESG, have you signed the Net Zero Asset Management Plan or made any of the other ESG pledges?
We have signed on to Share Action, which is a UK-government sponsored entity. They have a division called Workforce Disclosure Initiative, WDI. We signed down to that in November 2020, the first Indian company to do so, whether it was an investment firm or any corporate, first in India and the 51st in the world. They were going to see how we do in terms of many of the S factors and also some of the E factors and the G factors. But primarily S – how we treat our staff, what is the pay scale ratio, what is gender, about our supply chain. And in the process, we’ve learned a lot about ourselves.
Going back to the question on net zero. If you look back in history, there are about 1.5 trillion tonnes of greenhouse gases already emitted, and on most calculations, planet earth can withstand another 400 billion tonnes of greenhouse gas emissions before things start to get pretty bad. So our argument or thesis on Net Zero is it’s just a wash that a developed country company cannot worry about what happened in the past 50 years or a hundred years. Are they just offsetting what they’re doing with stuff happening in the developing world? If there are 400 billion tonnes of CO2 or CO2 equivalent yet to be emitted, who’s going to get the share of that? And do you also add the 1.5 trillion tonnes of the past when you try to go to net zero or is that forgiven? You built this tipping point but that last straw that breaks the camel’s back is the one you’re worried about. So we haven’t signed on to net zero. We haven’t signed on to UN PRI any of those, but we have signed on to WDI.
And why do you choose not to sign on to UN PRI or Net Zero?
UN PRI is self-attestation, it doesn’t tell me anything. Some of the largest asset management companies in the world have CEOs that write fantastic annual reports and very nice, glossy stuff. I don’t know who bought the shares we sold in L&T. But someone bought it and they still remain shareholders. It’s a very subjective field with a lot of uncertainty. There’s no one standard as yet, but we feel that self-attestation is not good enough. On Net Zero, we don’t like the cut-off date. We say, go back to the 1.5 trillion tonnes. And tell me what you’re doing about that and let the other 400 billion tonnes go towards the developing world, which may need to consume more and therefore have more GHG and more CO2 equivalents. It’s not the concept of Net Zero. It’s the starting point. Not today, go back in history and tell me what you’re going to do to offset the 1.5 trillion tonnes already up there in the atmosphere.
We’re not scientists, but we’d like to hear and see what companies are doing about it, what the consultants are advising them to do
So when you apply this to your portfolio and how you’re managing investments, how does that end up looking?
We’re looking at declining trends in CO2 equivalents from companies. And we talk to the companies about that. We have two portfolios. We have a value portfolio, which looks primarily at valuation metrics. So you go and meet a company, you work out its market share, operating margins, the future, its forecast. And then you try to figure out what it’s doing on ESG.
We have a company GAIL, which is a distributor of gas for NTPC, which makes power primarily from coal. We want to understand what exactly the company is doing to bring its CO2 emissions down or its reliance on hydrocarbon fuels down over the next few decades. The reality is that 40-50 per cent of India’s energy needs in the next 20 years will still come from hydrocarbons – unless there’s a phenomenal breakthrough in some kind of technology. So as we grow as an economy, there will be more consumption and there will be more GHG, but much of that consumption will be fuelled by hydrocarbons, a declining percentage, but it will be large enough. So we’d like to know what these companies are doing to bring those numbers down. That’s one portfolio.
The other portfolio does not own NTPC. It does not own GAIL because these companies don’t meet the minimum ESG score. They fail because they are bad today and they’ll be bad for the next five, seven or 10 years, probably. And so in that portfolio, we don’t have ESG-failing companies. We call it the India Responsible Returns portfolio that does not look at forecasting operating margins and sales growth and other traditional metrics but ensures that the companies that we’re investing in don’t go bankrupt tomorrow, don’t have high debt/equity ratios, are pretty solid financially, and they’ve made some profit over the last three years. It’s value with engagement to understand what’s happening over the next five to 10 years. Either you qualify or you don’t qualify.
Watch the full interview at https://www.youtube.com/watch?v=UiO9P89TGcA