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In the last couple of years, ESG funds have been a huge buzzword amongst the world of investors. ESG funds are invested with the intent of generating long-term financial returns in addition to promoting positive environmental, social and governance conduct. With climate change, corporate conduct, and fair rule-making becoming more well-known, Indian investors are more and more looking at ESG funds as an alternative for investing money according to their values. But what exactly are these ESG funds—and do you need to be investing in them?
What are ESG funds?
ESG funds are mutual funds or exchange-traded funds (ETFs) that invest in companies based on their performance in three non-financial but vital areas: Environmental (E), Social (S), and Governance (G). They screen companies not just for profitability but also for their natural resource use, treatment of employees and society, and ethics and internal governance.
For example, an ESG fund can steer clear of those companies engaged in fossil fuel or tobacco and prefer those with robust clean energy policies, gender equity, or operational transparency.
Why ESG investing is becoming popular
ESG investing has increased exponentially around the world in the last decade, and Indian markets are following suit. Many trends are fuelling this rise. First, more investors—especially younger ones—want to invest in a way that supports sustainability and responsible practices. Second, regulatory frameworks like SEBI’s guidelines for ESG disclosures have made it easier to identify and evaluate ESG-compliant companies. Finally, many ESG funds have demonstrated competitive returns over the long term, challenging the notion that ethics come at the cost of profits.
Are ESG funds profitable?
Whereas ESG funds used to be considered niche, more recent performance suggests that they are capable of competing on their own merits with traditional funds. There are some studies that suggest that ESG-compliant companies have improved risk control and lower possibilities of being fined by the authorities or experiencing reputational damage, which can be translated to consistent long-term returns.
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However, like all equity investments, ESG funds are at risk of market risks and may fall behind in the short term, particularly in rallies driven by sectors such as oil, gas, or mining that are shunned by ESG funds.
How to choose an ESG fund
When choosing an ESG fund, pay close attention to the fund’s strategy and its ESG scoring process. Not all ESG funds are created equal—some will have exclusionary screens, some will look for companies improving on sustainability metrics. Look at the portfolio of the fund, ensure the expense ratio is reasonable, and compare historic performance against benchmark indices. Some ESG funds popular in India are SBI Magnum Equity ESG Fund, ICICI Prudential ESG Fund, and Kotak ESG Opportunities Fund.
Is ESG suitable for you?
If you want to invest with a clear conscience and believe firms that are sustainability-focused will perform well in the long run, then ESG funds may be the best option. They are especially suited for long-term investors who have ethical considerations on par with financial goals. However, if your aim is short-term gains or investing in cyclical businesses that ESG funds may avoid including in their portfolios, a conventional mutual fund may suit you better.
Bottom line
ESG funds are the latest development in investor attitudes toward risk, responsibility, and reward. Not a cure-all, they are nevertheless a worthwhile option for those who want to build wealth while being part of a more sustainable and equitable economy. Like any investment, do your homework and consult with your advisor first, to ensure ESG fits with your financial plan.