ESG Funds: Should You Invest in These Funds?

Are you looking for ethical investments? Do you seek an investment that cares for the environment and promotes a social cause? You may consider putting money in ESG funds. It is a portfolio of equity-oriented instruments and bonds that focus on environmental, social, and governance factors.

ESG funds help you indulge in socially responsible investing. You may find investors showing a lot of interest in ESG funds in recent times. Many asset management companies have launched new fund offers to cater to the growing ESG segment. However, you may consider investing in ESG funds only if it matches your investment objectives and risk tolerance. 

What is an ESG fund?

ESG fund is a thematic mutual fund that invests predominantly in equity and equity-related instruments of companies that focus on the environment, social responsibility, and corporate governance. The fund manager looks for companies that adopt environment-friendly policies and follow ethical business practices. 

You may find mutual fund houses assigning scores to companies based on different parameters. It helps fund managers select stocks of companies with environment-friendly practices and an employment-friendly record. You may find ESG funds, excluding sectors such as tobacco, gambling, and liquor from the portfolio. 

The fund managers of ESG funds look at the carbon footprints of companies, waste recycling, emission norms, and energy practices. You may find the fund manager avoiding companies with regulatory issues and poor corporate governance.  

You could find the fund manager using the ESG score as a parameter to pick a company with environment-friendly policies and strong governance. It ranges from 0-100, and a high ESG score shows the company focusing on these factors. 

You may consider the performance of the Nifty 100 ESG index, which reflects the performance of companies within the Nifty 100 Index. It focuses on companies spread across IT, consumer goods, financial services and energy. You could find the Nifty 100 ESG index outperforming the Nifty 100 Index across different timeframes.

What is the scope of ESG funds in India?

The scope of ESG funds in India is steadily rising in recent years. Investors are focusing on ethical business practices, along with the financials of the company. You may find more than 3,300 ESG funds across the world. The value of global assets that apply environmental, social, and governance data to drive investment decisions was a whopping $40.5 trillion in 2020. ESG funds are gaining traction in India as mutual fund houses launch NFOs to tap a new class of investors. 

You may find millennials looking at corporate governance and ethical practices when selecting the stocks of companies. Indian companies are focusing on environment-friendly business practices to improve productivity and attract investors with strong principles. 

You could find tobacco companies and businesses that generate hazardous waste losing investments. It is because investors expect companies to follow ethical practices along with a focus on wealth creation. For example, you may not invest in stocks of tobacco or liquor companies even if they earn a high profit. 

Also Read: 4 Reasons Why You Should Invest In Mutual Funds Today!

You may find companies with high ESG scores having stronger cash flows and lower borrowing costs. Robust risk management systems reduce the probability of a negative event and enhance the brand image and profitability of the company. 

Should you invest in ESG funds?

• ESG funds invest mainly in shares of companies that focus on the environment, social, and governance (ESG) factors. You may consider ESG funds if you are an aggressive investor who prefers companies with environment-friendly practices and clean management.
• The Nifty ESG excludes businesses dealing in tobacco, liquor, and gambling. You may invest in ESG funds if you don’t prefer investing in these companies.
• ESG funds invest your money in companies that are free from major controversy and have strong corporate governance. If you invest in companies with no regulatory issues, you may get a higher return over the long-term.
• You may consider investing in ESG funds based on your investment objectives. It is suitable for a socially responsible investor.
• You may invest in ESG funds with a time horizon of over five years.
• ESG funds may focus on non-financial parameters. It could diversify your investment across ESG compliant firms. However, you may get a lower return as compared to a large-cap fund over some time.
• ESG funds, though popular across the world, are relatively new in India. You may have to wait for sufficient data on the track record of the scheme.

You may consider investing in ESG funds if you prefer companies with strong corporate governance and a focus on social responsibility.

How are ESG funds taxed?

ESG funds invest predominantly in equity-oriented instruments and focus on a particular theme. You would find short-term capital gains after a holding period of below one year, taxed at 15% with applicable surcharge and cess. 

You may find long-term capital gains after a holding period of one year or more, taxed at 10%. However, it would apply only to long-term capital gains above Rs one lakh in a financial year. 

Advantages of investing in ESG funds

• You may consider investing in ESG funds to achieve your long-term financial goals.
• ESG funds focus on themes such as green transport, renewable energy, and environmental protection. You could choose an investment that matches your value system along with sustainable investing.
• You may find companies with sound corporate governance policies and environment-friendly practices doing well over the long-run. It focuses on quality and better accountability which yields a higher return over some time.
• You may find the popularity of sustainable investing rising in India and across the globe. You could find the shares of ESG companies rising as millennials focus on this investment.
• You could find environmental regulations getting stricter as companies are forced to adhere to these norms. Investing in ESG funds ensures a higher quality investment as companies adhere to high standards of corporate governance.

Disadvantages of investing in ESG funds

• You may consider investing in ESG funds only if you understand the concept. It is a relatively new trend in India and has fewer investors as compared to other equity funds.
• You may struggle to diversify your portfolio with ESG funds. Many fund houses have recently launched ESG funds. You could struggle to find schemes with a sufficient track record of performance.
• You may find returns to be lower as compared to other thematic funds.
• You may find collecting data on the company’s social, environmental, and governance performance a tedious process. It could lead to issues such as data credibility which will hamper your decisions.
• You may consider the lack of market standardisation when you invest in ESG funds. It may have different names such as impact or socially responsible investing.
• There may be a shortage of ESG-friendly companies in India. Fund managers may struggle to find an appropriate investment.

You may find companies with low ESG scores losing importance even if they earn a high profit. It shows the importance of ESG funds as a sustainable investment. You could invest in ESG funds for the long-term to achieve your financial goals. ESG funds select companies with a high ESG score offering you an ethical investment. It focuses on clean management and social standards of a company. In a nutshell, you could invest in ESG funds to achieve your investment objectives only if it matches your risk appetite and value system. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in