'Funds based on this theme offer socially conscious investors an option to invest in a portfolio that is aligned to their beliefs.'
Schemes based on the ESG (environmental, social and governance) theme are gradually gaining traction among Indian investors.
Since the launch of the first fund in 2018, there are now nine such funds and one fund-of-fund, which together have asset under management (AUM) of Rs 12,026.7 crore.
All the funds are actively managed, barring Mirae's exchange traded fund (ETF) and fund-of-fund.
Over the past year, the category's average 12.2 per cent return is slightly lower than the 13.5 per cent fetched by the flexi-cap category.
This theme is immensely popular globally.
"About $35.3 trillion was invested in sustainability mandates in 2020, accounting for nearly 33 per cent of total global investment. In India, this number stood at 0.31 per cent at the end of January 2021. This is insignificant but also demonstrates huge growth opportunity," says Harsh Toshniwal, customer success lead-investment solutions, Refinitiv.
If a company or industry earns high profits but pollutes the environment, poses health risks to customers, or engages in other predatory practices, it inevitably invites regulatory clampdown.
This leads to erosion of its profitability and affects investors' returns.
To guard against such risks, mutual funds build portfolios using ESG filters.
They avoid businesses that can cause damage to society, such as tobacco, gambling, weapons of mass destruction, and so on.
All businesses they invest in are evaluated on ESG parameters.
Many investors want funds based on this theme.
"Funds based on this theme offer socially conscious investors an option to invest in a portfolio that is aligned to their beliefs," says Shrinath M L, senior research analyst, FundsIndia.com.
India's ESG-related regulations are evolving.
In October 2021, the Securities and Exchange Board of India (Sebi) had floated a consultation paper asking the mutual fund industry to specify its ESG investment framework.
Companies are also being asked to share more information with shareholders about progress on ESG parameters.
This is expected to make the functioning of ESG schemes more robust.
"Sebi is cognisant of the divergence in ESG evaluation methodologies and is working on bringing about some much-needed standardisation," says Shrinath.
Hindered by quality bias
ESG theme funds include high-quality stocks, with better disclosures.
These are generally well-discovered stocks that are optimally priced.
In a bull market driven by high liquidity, even low-quality stocks do well.
High-quality portfolios find it difficult to outperform.
With liquidity expected to go down in the coming days, investors are expected to turn to quality stocks. ESG funds could hence receive a boost.
Study the portfolio
According to Toshniwal, investors should examine the investment objective of the fund to see if it aligns with their investment philosophy.
They should also compare the fund's performance (both on risk and return parameters) with that of the benchmark.
Lakshminarayanan K G, senior fund manager, ICICI Prudential Mutual Fund, says investors should study a fund's portfolio before putting in money.
"Only stocks that score high on internal or external ESG ratings should make it into the portfolio," he says.
Who should invest?
Investors who are keen to further reduce risks in an already diversified portfolio may consider ESG funds.
"Investors for whom the means (investing in firms with relatively high ESG scores) are important may invest in these funds," says Lakshminarayanan.
Shrinath agrees. "Those who are particular about investing in funds that reflect their values can go for ESG Funds. But if you are purely investing for better returns, then diversified equity funds with consistent long-term track records would be a better choice currently," he says.
ESG funds have a very short track record in India.
ESG thematic investing works in the long term, so invest with at least a five- to seven-year investment horizon.
Feature Presentation: Aslam Hunani/Rediff.com