ESG Funds: For investing in firms with sustainable business models

Published: January 24, 2020 12:55:23 AM

Nifty ESG index has outperformed Nifty 100 since inception (2011) as well as in last one year on reward-to-risk basis

High ESG score indicates a firm being socially responsible, environment-friendly and robust in governance policies.High ESG score indicates a firm being socially responsible, environment-friendly and robust in governance policies.

By Pankaj K Agarwal & HK Pradhan

Are you the kind of investor who wants good returns but wants to invest in companies that have sustainable business models and exhibit strong commitment for the environment and the society? Well, for investors like you fund houses have launched a new product called ‘ESG Fund’.

ESG stands for Environmental, Social and Governance. ESG-investing is a strategy which involves investing in firms with a minimum ESG score. The ESG score ranges from 0-100 and is a weighted average of performance on various environmental, social and governance parameters. High ESG score indicates a firm being socially responsible, environment-friendly and robust in governance policies.

Such firms usually have lower risk of losses due to regulatory punishment, natural accidents or environmental controversies. Thus, in principle, high ESG score of a firm translates into enhanced value for investor. But does it lead to better returns too? A look at returns of recently created Nifty ESG index vs. its parent Nifty 100 indicates that the former has outperformed the Nifty 100 since inception (2011) as well as last one year; on Reward-to-Risk basis.

ESG mutual funds
For the conscientious retail investor, two ESG MF schemes have been launched in India by SBI MF and Quantum MF respectively. SBI Magnum Equity ESG Fund was launched in 2018 by re-categorising SBI Magnum Equity Fund whereas Quantum India ESG Equity Fund came into being in 2019.

The available pool of investable ESG firms is limited in India, unlike developed countries. Companies are waking up to identifying and reporting sustainability risks only at a snail’s pace. That said; the bottom line is that ESG funds are definitely a good product and not just a passing fad. Then, should retail investors add ESG schemes in their portfolio? After all, aren’t we generally advised against thematic funds as a class? Well, first, ESG investing is not really a new concept. Earlier also fund managers have always preferred sustainable firms; other things being equal. It is just that the current ESG paradigm provides a structured framework to filter firms, and that adds value. Given the growing emphasis on ESG factors in businesses all around, the future of the theme does look promising.

If you already hold a well-diversified portfolio, you may invest in ESG schemes and have some of the best firms in your kitty. However, for those who have just begun investing in MFs; have started small and are yet to achieve reasonable diversification in their portfolio, the right course would be to wait for these schemes to post longer-term performance numbers.

However, when index funds first came in Indian markets, many preferred to wait and watch. Performance data was allowed to accumulate and once the viability got established, index schemes just took off. If that happens with ESG funds too, given the global precedent, Indian MF industry is likely to have a new growth driver in them.

Pankaj K Agarwal is professor of finance, IMS Ghaziabad and H K Pradhan is professor of finance and economics, XLRI Jamshedpur

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