What you should know before investing in ESG funds (2024)

MUMBAI : A devastating Reuters photo of a starving stray polar bear in a garbage dump in the industrial city of Norilsk, Russia, hundreds of miles from its Arctic habitat, is a dark reminder of climate change. Like climate change, there are several other environmental and social issues which impact the world and call for informed, responsible choices in every aspect of our lives, including investments. Taking a cue from the current situation, the mutual fund industry has launched ESG funds—environment, social and governance-focused funds. Here is a look at what you should know before investing in ESG funds:

What you should know before investing in ESG funds (1)

WHAT IS IT?

ESG funds focus on non-financial factors of a company and invest in stocks of companies that have no evidence of any harmful environmental impact or any social risks; are committed to corporate social responsibility (CSR) measures; and do not have harmful relationships with stakeholder and the society at large. “Stocks of companies that manufacture products such as tobacco, alcohol and gambling are ruled out," said Chirag Mehta, fund manager of the Quantum ESG Fund at Quantum Asset Management Company Pvt Ltd. According to the Securities and Exchange Board of India (Sebi), ESG funds fall under the category of thematic funds. “The diversification will be limited to companies which fall under the ESG criterion," said Mukesh Dedhia, director at Ghalla Bhansali Stock Brokers Private Ltd.

In India, Kotak Mahindra Asset Management Co. Ltd was the first AMC to sign the United Nations’ principles for responsible investment initiative (UN-PRI) in April 2018. In February, Avendus Capital Public Markets Alternate Strategies, the alternate asset management arm of Avendus Capital, launched India’s first ESG fund—avendus India ESG Fund. The fund, which is run as an alternative investment fund, invests in the listed Indian equities based on pre-determined ESG factors using the company’s proprietary model.

Last year, SBI Mutual Fund renamed SBI Magnum Equity Fund to SBI Magnum Equity ESG Fund and launched the first ESG mutual fund in India. “After repositioning it as an ESG fund, there has been a change in the investment process which involves exclusion of certain sectors. Additionally, there are defined ESG parameters according to which companies are selected for portfolio construction. Certain stocks which were large cap-oriented but were a part of either exclusionary list (like ITC) or did not meet the requisite criteria pertaining to environmental, social or governance factors have been excluded from the portfolio," said Navneet Munot, chief investment officer, SBI Mutual Fund. SBI MF uses a combination of internal and external research to assess companies for ESG funds.

Last week, Quantum India launched its ESG Equity Fund and the new fund offer (NFO) ends on July 5. With an asset allocation of 80-100% in equity and equityrelated instruments that follow the ESG criteria and 0-20% in money market instruments and liquid funds, it is an actively managed fund benchmarked to Nifty 100 ESG Total Return Index. “Though Sebi classification requires it to be called thematic fund, the fund is more inclined towards being a diversified multi-cap fund," said Mehta.

SHOULD YOU CONSIDER IT?

To get a sense of how the ESG funds have fared, let’s look at the benchmark returns. The Nifty 100 ESG Index has a base date of April 1, 2011. Average return for the fund stood at 10.9% since its inception. Meanwhile, Nifty 50 index average returns were 9.5% and Sensex at 9.4% during the same time period, according to Valueresearchonline.com.

However, there is not enough data on individual fund performance as it is still a new product. “There is too little information in the market for us to assess the behaviour of ESG investing in Indian markets," said Chitra Iyer, founder, Mumbai-my Financial Advisor. However, experts say ESG funds are slightly risky because of the stricter compliance parameters. “If you are a first-time investor or one who has stayed in the markets for long, if you have the conscience to invest in Esg-compliant companies, you can look at ESG funds," said Iyer. And, it is not difficult to ascertain why investor conscience is critical for investment decisions into ESG funds. “For example, say there is a chemicals firm which is higher on the earnings barometer and may be fulfilling the CSR and corporate governance requirements, but finds it difficult to fulfil the ‘environmental’ needs of an ESG firm. This becomes a limiting factor," said Dedhia.

Investments in ESG funds will be taxed as your regular equity investments— long-term capital gains (LTCG) tax at 10% will apply to equity LTCG beyond ₹1 lakh held for more than 12 months and investments held for less than a year will attract short-term capital gains tax of 15% with surcharge and cess extra.

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