What are ESG funds and will it give good returns for investors in the fund?

What Are ESG Funds What are ESG funds and will it give good returns for investors in the fund?

What do we understand by ESG funds? OK, let us look at three diverse cases. Firstly, ice shelves are breaking off in the Arctic and threatening to increase ocean levels and submerge most low lying nations. Secondly, you find governments increasingly worrying about the ill effects of youth taking up smoking and drinking at an early age as it can have larger negative social consequences. Finally, we have seen cases like Yes Bank, Axis Bank and IndusInd Bank which have shown serious problems of corporate governance. When you combine these 3 factors, you get the premise of an ESG fund.

An ESG fund is, therefore, a fund that invests in:

  • Companies that contribute to protecting the environment
  • Companies that do not make products that disrupt the social balance
  • Companies that following standards of corporate governance

An ESG fund is all about the softer aspects of investment strategy

ESG funds focus on non-financial factors of a company and invest in stocks of companies that have no evidence of any harmful environmental impact or any social risks; are committed to corporate social responsibility (CSR) measures; and do not have harmful relationships with stakeholder and the society at large. In the Indian context how do we define such stocks? While it is hard to give a clear demarcation, we can take some examples. Companies that are into the manufacture, marketing or promotion of tobacco, alcohol and gambling don’t fit into this category as they are socially unacceptable.

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What about companies engaged in the production of coal and fossil fuels? Again these are ruled out as they are not environment friendly. According to SEBI, ESG funds fall under the category of thematic funds as per the latest SEBI classification. Similarly, companies that adopt lower standards of disclosure and corporate governance practices are also ruled out from being ESG compliant. The ESG investing is more based on negative list approach and removes companies that do not fit into the ESG criteria and then invests in the remaining universe based on normal financial matrices.

Are there ESG funds in existence in India?

Globally, ESG funds are quite common and many investors belonging to select communicates want to avoid exposure to certain types of stocks in their portfolio. For example, a staunch follower of the Shariah Law does not invest in liquor and gambling companies and Sikhs don’t invest in tobacco companies. A lot of new funds globally specifically reject any company that is contributing to global warming in a significant way. It has also been observed that such ESG funds do get better returns over longer periods of time and also such ESG compliant stocks get better P/E valuations in the market. Now let us turn to the Indian context. Here are 4 ESG funds in India you should know about.

  • Kotak was the first AMC to sign the United Nations’ principles for responsible investment initiative (UN-PRI) in April 2018.
  • The alternate asset management arm of Avendus Capital launched India’s first ESG fund—Avendus India ESG Fund. The company uses a proprietary model to identify ESG compliant stocks.
  • SBI Mutual Fund converted its Magnum Equity Fund into Magnum Equity ESG Fund. Now, the fund’s investment process involves exclusion of certain sectors. Additionally, there are defined ESG parameters according to which companies are selected for portfolio construction.
  • On a much smaller scale, Quantum India launched its ESG Equity Fund via an NFO. The fund will follow the ESG criteria for 80-100% of its portfolio with the balance allocated to money market instruments.

Is it worth considering ESG funds for investment?

ESG funds are classified as thematic funds by SEBI so there are not exactly an asset class but are part of the equity funds. As of now, it may be too early to evaluate the performance of ESG funds versus the Nifty and the Sensex and we may have to wait for a few more years to get comparable and verifiable data. There are two challenges. Firstly, the choice in a market like India becomes quite limited if the parameters are applied strictly. Secondly, most of the ESG companies in India are already quoting at rich valuations. That automatically makes the margin of safety limited. But ESG is surely a great idea nevertheless.

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