ESG mutual funds are a new trend in the Indian mutual fund space. I am sure you must have heard about it. Many new funds have been launched in the ESG space over the past few years and in 2020, 2021 and 2022.
But if you haven’t heard much about these, then don’t worry. For most people, I don’t think it’s such an important fund category that it will be sorely missed in portfolio.
But it’s getting some attention nevertheless, so let’s discuss it a bit.
ESG is an acronym for Environmental + Social + Governance. ESG focuses on sustainable investing where ESG mutual funds invest in a portfolio of stocks that are picked after assessing them on environmental (E), social (S), and governance (G) parameters along with other factors related to financial analysis and portfolio management. ESG companies are expected to have a positive societal impact.
Of the three among E, S and G, the governance (or G) is the most visible of the three ESG factors in India.
Globally, this trend has been picking pace for some time now. Have a look at the image below (source):
World over, there is a growing consensus that stocks picked on basis of ESG factors offer investors long-term performance advantages. That is the view. I don’t know whether it’s true or not.
There is another angle to it. And that is your personal inclination towards the ESG cause. This might be a higher cause above your other needs of portfolio seeking good long-term returns. You might also say that invest the ESG way is one way that you can give back to society, via your investments. If you believe in the ESG philosophy or support it strongly, then ofcourse, it’s a category you might be very interested in.
Related Reading – All mutual fund categories in India
But leaving aside the moral reasons for investing in ESG funds, is sustainable ESG investing a good idea from an investment perspective?
Does investing in ‘good’ really matter?
In India, most of the ESG funds do not have any long-term track record and it is still early days for ESG schemes in India. So it would be wrong on my part to comment without sufficient data.
So, which are the ESG funds available in India?
How many ESG funds are there in India?
As of now (Jan 2022), there are 10 ESG funds in India:
- SBI Magnum Equity ESG Fund
- Quantum India ESG Equity Fund
- Axis ESG Equity Fund
- ICICI Prudential ESG Fund
- Quant ESG Equity Fund
- Mirae Asset ESG Sector Leaders ETF
- Aditya Birla Sun Life ESG Fund
- Kotak ESG Opportunities Fund
- HSBC Global Equity Climate Change Fund of Fund
- Invesco India ESG Equity Fund
The total AUM of ESG mutual funds is about Rs 10,500 crore (as of May 2021). These are the funds from which (if need be), you need to pick a few to answer the question – What are the best ESG funds in India (2022).
Apart from the virtue signaling, at times ESG investing has been said to be getting popular as it at times, justifying higher fees by fund managers. Also, it is being said (here) that in a way, it provides a ready-made excuse for underperformance.
So there are people on both sides of the fence. Some say integrating ESG into the portfolio helps improve the performance. Here is an interesting take on why ESG is going mainstream. Some say ESG is not as good for investing as it is claimed to be. Sometimes, the same person makes both types of statements. But at different times depending on their incentives at a given point of time. 😉
I know some will like and others will scoff at the idea of ESG funds.
But how does the portfolio of ESG funds compare with funds of another category?
Even though ESG funds are classified as thematic funds, I think that for all practical purposes, the ESG fund is more or less like the Flexi-cap funds having a diversified equity portfolio that has companies doing well on the ESG parameters. But unlike other sectoral mutual funds and other thematic funds, I also see that ESG funds are much more well-diversified. It’s not that they stick to any specific sector or specific theme. So on that front, these are slightly less risky I think than the plain sector or thematic funds.
I am sure when I say that ESG funds will have ESG compliant companies in the portfolio. But I am also very sure that doesn’t mean that other fund categories will not have a few of the same ESG companies in their portfolios as well. Isn’t it? There is bound to be an overlap.
So let’s see how unique these ESG funds actually are. For this, I am picking the largest ESG Fund currently, i.e. SBI Magnum Equity ESG Fund which manages an AUM of about Rs 3500 crore. I will compare this fund’s portfolio for overlap with other category’s passive index funds or largest funds in the relevant active fund categories:
- 75% of the portfolio holdings of SBI Magnum Equity ESG Fund are overlapping with HDFC Index Fund (Nifty50 Plan).
- 57% of the portfolio holdings of SBI Magnum Equity ESG Fund are overlapping with HDFC Index Fund (Sensex Plan).
- 67% of the portfolio holdings of SBI Magnum Equity ESG Fund are overlapping with SBI Bluechip Fund (largest scheme in active large-cap fund category).
- 62% of the portfolio holdings of SBI Magnum Equity ESG Fund are overlapping with Kotak Flexicap Fund (largest scheme in Flexicap category)
- 60% of the portfolio holdings of SBI Magnum Equity ESG Fund are overlapping with Mirae Asset Emerging Bluechip Fund (largest scheme in Large & Mid-cap category)
- 54% of the portfolio holdings of SBI Magnum Equity ESG Fund is overlapping with Nippon India Multi-Cap Fund (largest scheme in Multicap category)
- 11% of the portfolio holdings of SBI Magnum Equity ESG Fund are overlapping with ICICI Prudential Nifty Next 50 Index Fund.
- 2% of the portfolio holdings of SBI Magnum Equity ESG Fund are overlapping with HDFC Midcap Opportunities Fund (largest scheme in Midcap category)
So as you can see, if you invest in some of the prominent funds in other fund categories (like large-cap index funds, Flexi cap funds, multi-cap funds, large & mid-cap funds, etc.), chances are that you will end up having about 50-70% same stocks in your portfolio that even the so-called ESG funds have. So from that perspective, it’s not much about portfolio uniqueness.
Suppose you hold one large-cap index fund, one Flexi cap fund, one large & mid-cap fund, and one mid-cap fund. Then I am sure you will hold an overall portfolio of stocks that any ESG fund might have. So a major chunk of ESG stocks will also find a place in the portfolio of any well-diversified but non-ESG equity funds.
So I am very sure when I say that ESG funds will 100% have ESG compliant companies in their portfolio. But I am also very sure that doesn’t mean that other fund categories will not have a few of the same ESG companies in their portfolios as well. Isn’t it? There is bound to be an overlap. And this is what we saw in our comparative analysis above.
And what about ESG companies in India? Can you invest in them directly?
Ofcourse you can. If you have strong ESG feelings about few companies, then go ahead and buy their stocks directly instead of doing it via ESG funds. And how to find out which are the ESG compliant companies in India?
Best to look at the portfolio of ESG indexes available in India. There are 4 ESG indexes:
- Nifty 100 ESG Index – This is a subset of Nifty 100 companies but as of now, has only 88 companies. To form part of the index, the stocks should be part of the Nifty 100 index and also have an ESG score. Read more here.
- Nifty 100 Enhances ESG Index – In the case of the Nifty 100 enhanced ESG index, the companies should have a normalized ESG score of at least 50% to be included in this index. Read more here.
- Nifty 100 ESG Sector Leaders Index – The Nifty100 ESG Sector Leaders Index aims to track the performance of select companies within each sector of the Nifty 100 which have scored well on management of ESG risk and which do not have involvement in any major controversies. Read more here.
- S&P BSE 100 ESG Index – Read more here.
These are the stock indices that include companies meeting the ESG criteria in India.
In India, very recently I saw that the rating agency CRISIL has now got into ESG rating and has begun ESG scoring with 225 companies. This is one more piece of evidence that, slowly but surely, ESG is getting into the decision matrix of the governments, regulators, investors, lenders, and corporates.
One potential benefit of ESG compliant companies is that they may get higher foreign inflows in future. Many countries and investment funds based abroad give a lot of weightage of ESG. So its natural that when such entitites come looking for Indian stocks to invest, the ESG compliant Indian companies will gain from such inflows.
Note – Not just the mutual fund space, but the world over, there is an ongoing effort across the cryptocurrency space to make the crypto assets more ESG Friendly. As of now, and from what I have read about it, Bitcoin investment is challenging for many ESG-conscious investment entities from an ESG perspective. Read more about whether to invest in Bitcoin or not.
Should you invest in ESG Funds?
If we were to leave aside the moral reasons, then I don’t think there is a need.
As long as you pick a few good-quality mutual funds with a solid portfolio of stocks, I don’t think you need a separate ESG fund as a part of your mutual fund portfolio.
Also, ESG investing is still in its nascent stage in India and there isn’t much data (or track record) of the ESG funds for me to suggest that they are worth taking a bet on. But that doesn’t mean that they are bad. I am just saying they are not important for your portfolio, as of now.
And if you are looking to beat the index and go for generating alpha, then its not that incremental generation of alphas is only restricted to ESG stocks alone. There are sufficiently large universe of such opportunities in the non-ESG universe of Large & Mid and Small Cap listed space as well.
So I guess, wait-and-watch is the best approach for ESG funds. Let the theme evolve a bit more in India. And if you really want to do something good (morally) in the E, S, or G space, then I am sure you will find other ways to do that.
Also given the nature of how things work in India. running ESG investing in or from India in its real form would mean making some very hard choices. And that is easier said than done.
How to pick funds based on the ESG theme?
ESG fund performance in India has a very small track record. So let’s not depend on it. Some also say that ESG Funds are best positioned to provide good (very) long-term sustainable returns. Is it true? Or is it a trend that we cannot afford to miss? I don’t know sorry. If you invest in it, you might do well. Or you might not. And given the very subjective nature of E, S, and G parameters, how can you be ever sure about whether it’s the ESG factors that are giving you good performance or something else? Something to ponder over. Isn’t it? And in the case of ESG, measuring what matters is all the more difficult due to the poor quality data available in India about ESG factors.
So that is about What are ESG funds and Should you invest in ESG funds in India (2022).