Responsible investing: ESG mutual funds are gaining traction, for all the right reasons

Vijay C Roy

The enhanced focus on embracing sustainability is having an impact on investment goals too. ESG or Environmental, Social and Governance mutual funds invest in companies that are committed to environmental conservation, social responsibility and corporate governance practices. The fund aims to provide decent financial returns while also positively impacting the environment.

Benefits

• One can contribute to positive social and environmental change.
• Portfolio diversification by investing in ESG purpose-driven companies which reduce traditional risks.
• May result in long-term gains in terms of the high growth potential of ESG-compliant companies.

The first ESG fund in India was SBI Magnum Equity ESG Fund, introduced in May 2018. The ESG theme or responsible investing garnered popularity post-Covid. Between 2020 and 2021, eight new ESG funds were launched.

As of January 3, 2024, 10 ESG schemes across various fund houses were managing assets worth Rs 10,946 crore. Besides SBI, some of the ESG Funds are Mirae Asset Nifty 100 ESG Sector Leaders ETF, Quantum India ESG Equity Fund, Invesco India ESG Equity Fund, Kotak ESG Opportunities Fund and ICICI Prudential ESG Fund.

Experts feel that such funds will attract greater attention in the coming years.

“At the moment, the demand from retail investors is less mainly on account of lower returns as compared to mid-cap and flexi cap. In addition, the awareness level is also low,” says Rajeev Kathuria, a mutual fund distributor based out of Chandigarh. However, he is hopeful that with growing concerns about environmental and social issues, coupled with regulatory initiatives to promote ESG investing, the demand for ESG funds would rise in the future.

Insiders share that globally, flows into sustainable funds are continuing at a rapid pace, with assets in such funds reaching nearly USD 3 trillion as of December 2021. It’s still early days in India from an ESG perspective, but with the launch of several ESG funds in the last few years, there are responsible investable options available for investors.

Acknowledging the growing interest worldwide for sustainable investing, capital markets regulator SEBI is also coming out with proposals around sustainable investing and disclosures. By providing clearer guidelines and promoting responsible investing practices, SEBI’s initiatives can enhance investor confidence in ESG funds and foster the growth of this segment.

In July 2023, the market regulator allowed asset management companies to launch multiple ESG schemes with different sub-strategies like exclusion, integration, best-in-class and positive screening, impact investing, sustainable objectives, and transition or transition-related investments.

ESG vs traditional MFs

ESG mutual funds focus on investments in companies that have received good ratings on ESG factors and aim for sustainable growth. Traditional mutual funds, on the other hand, invest in companies based on their profitability, past performance, growth, etc, without considering ESG factors. Secondly, ESG funds effect positive social and environmental change by investing in companies that are best at lowering their carbon footprint or have good practices in dealing with employees. Also, ESG funds prioritise sustainability over short-term gains, while traditional funds primarily focus on financial returns.

Types of ESG MFs

ESG mutual funds come in various forms, each with its unique investment strategy. Some common types of ESG funds are:

Exclusionary funds: These include companies that do not meet the ESG criteria and are involved in services/products such as tobacco or fossil fuels.

Best-in-class funds: These funds invest in companies with the best ESG ratings within their respective industries.

Thematic funds: These funds invest in companies focused on sustainability themes such as clean energy, gender diversity, or water conservation.

Impact funds: Investments are made in these types of funds to gain financial returns along with generating measurable and beneficial environment and social returns.

What the future holds

According to insiders, it is beyond doubt that sustainable enterprises are the future and investing in them is an ethical alternative, but how these funds perform in the long run is yet to be seen.