Ajit Dayal's views on Impact Investing

In an interview, Ajit Dayal, the Founder of Quantum Advisors tells us what excites him about ESG / Impact Investing.

 

You had said you had retired….

Yes! As part of a long-term succession plan, I.V. Subramaniam (Subbu) had taken over the role of the CEO of Quantum Advisors in 2013. In August 2016, the Fairfax group of Canada had purchased a 49.8% equity stake in Quantum Advisors and we now had a long-term, patient institutional investor to support our long term plans with sufficient capital to, firstly, build the local Quantum Mutual Fund platform and, secondly, to allow us to grow the international list of clients. By August 2017, I had quit the Board of Quantum Advisors and Quantum AMC – though I still remain as a Member of the Portfolio Team, which oversees the portfolio construction process. After having worked for 27 years to lead the team to build Quantum, it was time for Subbu (we have worked together since 1996) to guide the future of Quantum with the remarkably talented and accomplished leadership team. We had created a Charter of Principles that guides how Quantum will behave as an entity in the future. Yes, I had retired.

 

How did you spend your time?

Between August 2017 and October 2018 – for over one year – I was travelling to meet people and see what was happening in the world. Not only to meet clients but also connecting with friends across all walks of life and spending time with members of my family. I had no office hours though I was in touch with my colleagues on the Portfolio Team. But I was not party to the business decisions of running the company. Yes, I was there to help and assist if asked but there was no formal role – more of a guide and a mentor. I was offered the role of Chairman Emeritus but felt that this would be an undue influence and possibly cast a shadow on independent decision-making, This was a very different experience for me: No responsibility on business deliverables and a lot of freedom to explore.

 

So, how did you get back to work?

Well, in October 2018, I got a call from Mukund Rajan, who had been the Chief Ethics Officer and Brand Custodian of the Tata Group. I had interacted with Mukund while he was at Tata and when I was still active in Quantum. Mukund informed me that he had left the Tata Group and had co-founded E-Cube, a consulting company focused on helping Indian companies improve their ESG practices. But ECube felt they needed to start a ESG fund to create more awareness of their activities and create a larger impact on Corporate India. Mukund asked if I knew of any fund manager I could introduce ECube to. Luckily, retirement had not dulled my brain!

Quantum has an “integrity” or “governance” screen in its research and portfolio construction process that has been applied to the client portfolios for 25 years. Towards the end of my tenure at Quantum, we had formalized a database to score “G” for Governance and also added the “E” (Environment) and “S” (Social) factors that were gaining ground over the past few years. We had asked third-party ESG scorekeepers for their sample reports on groups like Reliance, Essar, Vedanta – companies that Quantum was not likely to invest in – and were surprised to find that these groups were given high scores by these local and international “ESG scoring” firms. So, rather than buying a data-feed that seemed questionable in its rigour and controversial in its output, we decided to build our own database. We had started that effort in 2015. And then, as an extension of that, we had filed with SEBI to launch an ESG fund on the Quantum Mutual Fund platform for domestic retail investors (Quantum India ESG Equity Fund). So, when Mukund called for advice on which fund manager to hire for ECube’s proposed idea of a fund, I replied: Talk to Quantum!

I relayed the conversation I had with Mukund to my colleagues at Quantum and they agreed that a meeting with E-Cube should be set up. I had met Mukund and his colleagues to sort of break the ice prior to the meeting with Quantum and not really be involved in the outcome of that meeting. As part of furthering my understanding of ESG, I asked the ESG Research Team at Quantum for some macro data. And what I found shocked me. I googled a bunch of words on the internet to see if what we had “discovered” was being discussed and resolved by anyone and found – to my surprise – that no one was focusing on this alarming “discovery”. I reviewed the data of our research and felt that I must do something. So, I went back to my colleagues at Quantum and asked if I could lead the effort of setting up a joint venture with E-Cube and then leading the effort to build the team for this new venture. They readily agreed – and that is how I am back at work: I now have a schedule!

 

What was this “discovery” that brought you back to work?

By 2035, the Greenhouse Gas (GHG) emissions in the world are supposed to remain at 60 billion tonnes under the Paris Climate Accord – that is the level of GHG emissions today. India is a signatory to the Paris Climate Accord and has made a commitment that the energy required to produce a 1% growth in GDP will decline by 30% over these next 16 years. Despite this assumption and using historical data on India’s GDP, and extrapolating expected growth rates in the future, we estimated that – if India continued to follow the demand pattern of economies like China, Europe, North America over the next 16 years – the additional GHG caused by the explosion of demand in India alone could turn that 60 billion tonne GHG limit into an actual figure of between 67 billion tonnes and 82 billion tonnes. This is 12% to 34% above the limit agreed to by 195 countries. Something needs to be done in the technology and its adoption in production processes to allow an Indian to consume the same way a Chinese, European, or American does - without messing up the GHG emission targets.

There is a myth here that needs to be busted. The myth is that an individual can and must change their consumption patterns to reduce GHG emissions. That is a guilt-induced marketing campaign encouraged and probably financed by large companies: it is like pushing a large rock with a string and hoping to make the rock move. The onus has to be on companies to create products that are GHG efficient and then offer these GHG efficient products to the consumer via sensible distribution channels. There are 100 companies in the world that account for over 70% of all GHG emissions: shouldn’t the onus be on them to reduce their GHG footprint? Why should 7 billion people have to change when a change at 100 companies will make a larger and more lasting impact? Telling me to fly less is pointless when fares are inexpensive. So maybe you force a GHG tax regime that makes airfares prohibitive for me to fly often - or force the airlines and airplane manufacturers to invest in more fuel efficient aircraft. Telling a consumer to avoid single use plastic bottles is idiotic when no one is telling the manufacturers to stop producing them.

Taking the concept of Say’s Law and applying it to this situation: Supply creates its own demand. If the manufacturers produce monetarily inexpensive single-use plastic, people will find ways to use them. The “external” cost to society by excessive plastic in the environment is not paid for by the company that produced the cheap plastic to encourage the use of plastic – it is paid for by society. This is called “externality”. For example, asbestos was known to cause non-cancerous respiratory diseases which resulted in deaths and costs to society for paying the medical bills of those impacted by asbestosis. Tobacco companies manufacture products that also kill people and leave the price tag of their actions to society. Both these industries have had to pay billions of dollars in fines to individuals and governments. Maybe it is time for the plastic manufacturers and fossil fuel producers to start paying for the “externalities”? Or for companies like L&T which are building a potentially environmentally hazardous coastal road to start keeping aside a pool of money to pay for fines that may fall on them in the future? If the Boards and CEOs of companies started focusing on “externalities”, their decisions may be different and more beneficial to society?

So are you a flag-waving climate activist?

Assuming there is a “climate crises”, there is enough capital in the world to support the creation of technologies and their adoption into mainstream production processes. As the climate icon, Greta Thunberg, has pointed out all that has happened for the past 25 years has been a lot of talk – and little action.

I am not a climate alarmist and don’t claim to be a scientist. There are enough scientists who believe that the changes in climate are not caused by humans. They also believe that the world needs more carbon, not less carbon. I am not in any position to evaluate the “correct” hypothesis. But it is the math that scares me. If many scientists in the world are nervous about a 60 billion tonne GHG emission target in 2035 being a poor compromise which can still harm life on planet earth, then the fact that economic growth and consumption patterns in India alone could take the GHG emissions to 67 billion tonnes or 82 billion tonnes should be a wake-up call. The math frightens me. India is Ground Zero, Patient Zero in the fight to limit the damage due to GHG emissions – and no one is aware of this!

 

 

What is the objective of the proposed Fund?

You cannot tell an Indian (or an Indonesian or an African) that they must consume less – they will rightfully say that the Chinese, Europeans and Americans have all had their decades of consumption binge and how dare you deny us that same right to consume more. What you can do is try to find ways to allow the consumption - but reduce the GHG impact. So the idea is to raise anywhere from USD 350 million to USD 1 billion in the proposed Q-ECube India Active ESG Fund*. The capital raised will be used to purchase a 5% to 9% equity stake in a company and provide funding typically in the range of USD 40 million to USD 60 million to a company so that the company can use this capital to re-tool its production processes, buy and implement new technologies and offer products that meet the demands of the consumer – but yet limit their GHG emissions.

 

Why the partnership between Quantum and ECube?

The seasoned team of our JV partners at E-Cube will sit on the Board of the companies we invest in and guide the management on the implementation of an agreed long-term pathway. Quantum’s role in the JV is to work on the entry price valuations and estimate the potential for profit over the long run based on various projected outcomes from the investment in new machinery, new processes – we don’t know how to run companies or improve companies. That is not our skill set. The partnership between Quantum and E-Cube allows each party to bring something unique to the table and, we believe combining our skills the 1+1 should be far greater than 2.

 

How does this differ from the Quantum ESG India Fund that is available to retail investors on the Quantum Mutual Fund (QMF) platform?

QMF’s ESG India Fund buys share of companies that meet a certain minimum score in the ESG analysis done by the Quantum ESG Research team. As long as the ESG score stays above a minimum, the stock can be held in the QMF ESG India Fund portfolio. The Fund is not “active” in the sense it is not advising the company what to do to maintain or enhance its ESG score or helping it achieve that higher ESG philosophy and practice. QMF’s ESG India Fund may have a large cap bias in the portfolio since many large caps are likely to be reporting good ESG scores. In contrast, the Q-ECube India Active ESG Fund is different because it would be buying into companies that may have low ES  scores but have a desire and potential to improve their scores – and we are providing the company with the capital and the knowledge and guidance (via a Board seat) to evolve from a lower level of ESG to a higher level of ESG. These companies are likely to be small-cap or mid-cap companies - which may not have access to the capital or expertise they need to improve their ESG practices. So the local fund and the international fund are very different in objective and scope.

 

What are the trends you are seeing in ESG investing in the world?

I have been meeting many people in London and Europe. These are the geographies where ESG is more serious. It is a new form of investing in many ways and the nomenclature is evolving very rapidly. Impact investing was seen as investing in building a prison or managing a prison rehab programme and seeing the outcome, measuring that against a base cost and generating returns for the investor based on money saved against the base case scenario. ESG investing is seen as investing in a company and trying to ensure they have good corporate governance, no child labour and some reporting metrics on the environment. In between these you have Responsible Investing, Sustainable Investing…. What we are doing in Q ECube India Active ESG Fund is trying to ensure we have good governance in the companies we invest in but the focus has to be on reducing the adverse impact of that company’s operations on the environment. Governance is key, working with the management and the founder is key, climate impact is key.

There is no standardized definition of what each of these various kinds of investing are to be called. We have seen some of the largest fund management firms in the world publish glossy annual reports with claims of focusing on the society and, yet, their investments – or their internal pay scales – fail the test of companies focused on the Triple Bottom Line: Planet-People-Profit. I heard a speaker at a conference in London recently lambast these sultans of swindle as selling counterfeit funds and indulging in green-washing: pretending they are green but continuing to debase the principles of ESG with their poor practices. This is a real danger. The financial firms, in general, love the taste and smell of money. ESG Investing is a new trend. In finance we have a saying, “the trend is your friend” - so the asset gatherers will churn out products because they see money in doing so. We witnessed that in India in the BRIC era when long-short hedge funds (even though it was then illegal to short stocks!), and the great India story funds were all launched. After the Lehman collapse, the fund managers said “we only gave you what you asked for”! In our industry we are experts at extracting from the wallets of gullible investors. This will extend to the ESG / Impact space: that is a reality and, hence, a danger.

 

How excited are you about this new Q ECube India ESG Fund?

Typically, I hate travelling in cold weather to the western countries. I would rather be in Bombay and Goa this time of the year. Yet, I have made – and am still making – many trips to Europe and America for this Fund. So either I am crazy – or I am committed!

*The name used for the proposed fund (“Q-ECube India Active ESG Fund”) is used only for reference / illustration purpose and may not be considered as the actual final name of the proposed fund. The proposed fund is yet to be constituted and launched, and is currently not registered in any jurisdiction.

Disclaimer: The information contained, and the views and opinion expressed, above is not an investment advice. Further, the information contained above is not an offer to raise or solicit an investment and should not be considered as such. It is merely a description of the business and proposed product launch.