The Rise of ESG Mutual Funds: Investing for a Sustainable Future

In the last few years, consumers have become environmentally conscious, and the mutual funds segment also reflects this trend. Interest in sustainable investing has soared in India, with ESG (Environmental, Social, and Governance) funds gaining popularity.

So, what are ESG funds, how do they work, and is it something that you should invest in? 

Let’s find out.

Understanding ESG Mutual Funds

ESG mutual funds are like any other mutual funds, except they invest in companies that prioritise environmental protection, social responsibility, and good governance practices. By investing in these funds, you support eco-friendly, socially conscious, and well-managed businesses, aiming for positive impact alongside financial returns.

For example, Tata Consultancy Services (TCS) focuses on energy efficiency and community welfare. Infosys is known for its sustainability initiatives and green buildings. Wipro invests in renewable energy and social programmes. These are often included in ESG mutual fund portfolios.

Types of ESG Mutual Funds  

Here are some of the commonly available types of ESG mutual funds:  

• Environmental funds: These funds focus on companies with strong environmental practices, like renewable energy or waste management.
• Social funds: These funds invest in businesses prioritising social issues, such as employee welfare, community development, or diversity.
• Governance funds: These funds target firms with robust corporate governance, transparent management, and ethical practices.
• Integrated ESG funds: These funds combine environmental, social, and governance criteria to create a balanced portfolio.
• Thematic ESG funds: These funds focus on specific sustainability themes. For example, clean energy, water conservation, sustainable agriculture, etc.

You may also like to know that the Securities and Exchange Board of India (SEBI) has introduced a separate sub-category for ESG investments under the thematic category of equity schemes. Now, any scheme under the ESG category can be launched with one of the following strategies:

• Exclusion: Avoiding investments in companies that do not meet certain ESG criteria.
• Integration: Incorporating ESG factors into the investment analysis and decision-making process.
• Best-in-Class & Positive Screening: Selecting companies that perform better on ESG criteria compared to their peers.
• Impact Investing: Investing with the intention to generate measurable social and environmental impact alongside a financial return.
• Sustainable Objectives: Focusing on investments that contribute to sustainable development goals.
• Transition or Transition-Related Investments: Supporting companies that are transitioning towards more sustainable practices.

ESG Funds: How and where do they invest?

ESG funds carefully select companies based on environmental, social, and governance practices. 

For example, the SBI Magnum Equity ESG Fund has invested in companies like Tata Consultancy Services (TCS), Infosys, and HDFC Bank in its portfolio.   

These funds carefully evaluate potential investments through rigorous screening processes to ensure they meet specific ESG criteria. By choosing these investments, ESG funds aim for financial returns and promote sustainable and ethical business practices.

Why ESG Investing is Gaining Momentum in India

As mentioned earlier, ESG funds investing is rapidly gaining traction, and for good reason. As per reports, 10 ESG schemes across various fund houses are managing assets worth ₹10,946 crore. 

So, what’s driving this momentum, you may ask?

The Securities and Exchange Board of India (SEBI) has mandated that the top 1,000 listed companies disclose their ESG efforts. With this move, there is better transparency and accountability among companies. Moreover, this transparency allows you to be well aware and invest in companies that have well-defined sustainability practices.  

On the other hand, many Indian companies are now committing to sustainability and responsible business practices. This commitment often translates into better long-term performance. Also, it is an attractive investment for you as an investor as such investment offers stable and ethical investment opportunities. Additionally, companies that prioritise ESG factors tend to have more resilient business models, making them appealing choices for your portfolio.

Benefits of Investing in ESG Mutual Funds

Investing in ESG mutual funds offers multiple benefits. 

• Firstly, ESG funds align your investments with your values, supporting companies committed to sustainability, social responsibility, and ethical governance. This ethical approach can also lead to better long-term financial returns, as companies with strong ESG practices often perform well and are more resilient.
• Additionally, ESG funds ensure companies are open and honest. This automatically lowers the risk of investing in poorly managed or environmentally harmful businesses.
• By investing in ESG funds, you contribute to positive social and environmental impacts while potentially enjoying steady returns. Now, that’s what you would call a win-win for your portfolio and the planet.

How to Invest in an ESG Mutual Fund

To invest in an ESG mutual fund, start by researching and selecting a fund that matches your values and financial goals. Use a trusted investment platform or invest directly through the fund house’s website. Just like any other mutual fund, you can choose to invest via a lump sum investment or set up a Systematic Investment Plan (SIP) for regular contributions. Make sure to regularly review your investment to ensure it aligns with your objectives.

Challenges and Considerations in ESG Investing

ESG mutual funds come with certain challenges and risks that you should know before investing in them. 

• Firstly, ESG reporting is still evolving. So, while one fund might prioritise carbon emissions, another may focus on labour practices. This variation in the approaches of different funds can make it challenging for you to compare funds effectively.  
• Sometimes, investing ethically can mean not investing in high-performing companies that don’t meet ESG standards. 
• Often, there is a fear of companies not adhering to their commitments. If you invest in ESG funds, you may have to keep an eye on the companies included in your portfolio. This is primarily to ensure that they are adhering to their sustainability commitments. 

In the end, remember that if you include ESG mutual funds in your portfolio, you could be contributing to a sustainable future. But, the rewards of this investment will depend on whether you are prioritising sustainability alone or focusing on portfolio returns as well. A smart move would be to carefully check the portfolio composition of an ESG fund before you park your funds in it.