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How to pick funds based on ESG theme

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The theme was initially driven by institutional investors but is gaining traction amongst retail investors too. There are about 10 funds to choose from in India, based on factors such as active or passive funds, invested in Indian equities, or global ones.

ESG funds are mutual funds calibrated using environmental, social, and governance propositions. “ESG funds invest in companies that aim to have a sustainable and societal impact in the world, such as those with a small carbon footprint or diverse leadership boards. An ideal fund would be the one that invests in companies that ace these propositions while ensuring that an investor is not compromising on their returns,” said Priti Rathi Gupta, founder, LXME, a financial platform for women.

This World Environment Day we tell you why this theme has picked up and its prospects in the Indian context.

Why ESG funds have picked up

Private investors have realized that investing in companies with a robust and convincing ESG strategy positively affects return on investment, reduces lending and revenue risks.

Moreover, ESG principles guide corporates towards better and more efficient use of resources, both natural and man-made. This facilitates businesses to sustain for longer with the same limited pool of resources.

“ESG funds are playing an important role of creating a push for corporates to be aware of these aspects by avoiding investments in those companies or sectors where underlying risks in businesses due to disregard of E, S or G factors is high and by engaging with corporates increasing the awareness levels,” said Amit Nigam, fund manager, Invesco Mutual Fund.

The covid-led crisis has further accelerated the demand for sustainable investing. While still early days in India from an ESG funds perspective, the launch of ESG funds has increased investor awareness.

“Many domestic asset managers are already incorporating ESG principles in their overall investing framework. Corporate India is also increasingly acknowledging the need to effectively manage the ESG factors as means to effectively manage business risks as well as attract long-term capital from investors who are increasingly considering ESG factors to make investment decisions,” said Kaustubh Belapurkar, director – manager Research, Morningstar India.

Low environmental score

There have been concerns that in India many top companies score low on the environmental aspect, which is then compensated by good social and governance scores. Some of the large companies scoring low on the environment is a factor of the industries in which they operate.

“The industries’ usage of natural resources and subsequent emissions are the main reason of these poor scores. In our scoring methodology, we weave in these aspects, and try to differentiate between companies that are making efforts to mitigate this risk by improving on their processes making more efficient use of natural resources, reduce emissions etc,” said Nigam.

On the other hand, there are examples of companies, which had a good score on the environment aspect, yet they damaged shareholder returns due to poor governance practices.

“Our experience of ESG principles suggests that one should have a holistic approach when evaluating the ESG risk profile of a company,” Nigam added.

Are ESG funds a good fit for you?

According to experts with the risk lowered, investors in such funds stand to benefit from better risk-adjusted returns in their portfolios over the medium to long term.

A strong ESG proposition can help create business value across the enterprise. “E-sustainable practices attract more customers, allows better access to resources, lowers energy and water consumption, and therefore also can reduce operational costs. S-sustainable practices lead to greater social credibility, attract talent, boost employee morale, and build stronger community relations. While G-sustainable practices may lead to government support, subsidies, overcoming increasing regulatory pressure, and better investor relations, e.g., in form of better loan conditions or lower capital costs,” said Gupta.

According to Nigam, investors in a company stand to benefit from this extended life as the equity compounding journey in the company can continue for longer.

Top-rated funds

ESG funds in India are still at a nascent stage but those that have been around for more than a year have shown impressive returns. According to Morningstar India, top-rated ESG funds are Aditya BSL ESG, Axis ESG Equity, ICICI Prudential ESG, Invesco India ESG Equity and Kotak ESG Opportunities.

In terms of the environmental aspect, information technology and financial services sectors tend to attract a better score, as these businesses have a limited direct physical interaction with the environment.

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