Should I include ESG or other new-age funds in my existing portfolio in my 40s?

In recent years, investors have become curious about new-age investment themes like ESG (Environmental, Social, and Governance) funds

ESG investing
Know about ESG investing in your 40s and associated risks. Representational image

By Anup Bansal

Investing in your 40s is uniquely challenging. You have to meet your short-term goals such as your child’s education, buying a house, etc., while ensuring your long-term goals like retirement are on track. Thus, an investment portfolio that reflects asset allocation and risk diversification based on your life stage and goals is a must.

Including equity, fixed income, or alternative assets like gold in a portfolio is not new. However, in recent years, investors have become curious about new-age investment themes like ESG (Environmental, Social, and Governance) funds. 

The popularity of these funds has increased immensely since their launch in India in 2018. While thematic investing in sustainability via ESG funds is a welcome change, the question is should you tick the ESG box, too? Let’s find out. 

How does ESG investing work?

In theory, including ESG funds, helps you to focus on sustainability and avoid corporates polluting the environment or exploiting human resources. ESG consists of three factors: environmental, social, and governance.

  • Environmental: How resilient are business operations over environmental and climate risks, i.e., initiatives to reduce carbon footprint, soil/water conservation, etc.
  • Social: How a business contributes to its stakeholders and community, i.e., fair wages and labour policies, social charity, gender equality, equal pay, etc.
  • Governance: How efficient and competent is the business leadership? I.e., leadership initiatives for employees, transparency in audits, accountability, etc. 

The ESG criteria of each fund differ based on their screening preferences. 

Negative screening: In negative screening, investments are made by excluding negative characteristics. For example, not investing in a company that impacts the climate beyond the industry standards. 

Positive screening: This technique includes investing in companies prioritising ESG factors, i.e., gender diversity, higher employee retention rate, etc. 

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To decide on a suitable ESG fund for your portfolio, these screenings and available ESG scores are essential. They help you compare risks for investing in different funds and their exposure to ESG parameters. 

What should you consider for investing in ESG funds?

As a conscientious investor, if you plan to include ESG funds in your portfolio, ensure that you consider your requirements first. Make sure the ESG funds you choose reflect the same and add value to your portfolio.

ESG funds comprise companies that focus on non-financial elements which may not reflect on the bottom line but will contribute to the overall growth. Investing in companies that instil higher moral values for their governance and prioritise environmental protection and social development gives you a sense of satisfaction. 

In the last three years, ESG funds in India have grown 6-folds. The data from Morningstar India shows that the fund size of ESG funds stood at Rs. 12,447 crores as of March 2022, up from Rs. 2,268 crores in March 2019. 

In the long run, these values may reflect positively on your portfolio more than the actual returns.

The performance of some of the ESG funds is captured in the table below. 

ESG Fund Name1-year CAGR3-year CAGRCAGR Since Inception
SBI Magnum Equity ESG Fund -3.7%13.2%11.7%
Axis ESG Equity Fund-14.3%14.1%
ICICI Prudential ESG Fund-6.2%13.9%
Kotak ESG Opportunities Fund-9.9%6.2%
HDFC Housing Opportunities Fund -2.4%11.7%5.1%
Source: Scripbox

As seen in the table, the short term performances are in red. However, the long-term returns are comparatively better. 

Shortfalls of ESG investing 

If diversification is your primary goal for ESG investing, it is better to research the degree of diversification you can expect from the fund. Sometimes, ESG funds do not provide any real diversification to your portfolio. 

For example, SBI Magnum Equity ESG Fund is the largest ESG fund in India. Its top holdings are Infosys, ICICI bank, HDFC bank, Larsen & Toubro Ltd, Mahindra & Mahindra Ltd, TCS, and more. If you already have invested in these stocks or have invested in large-cap mutual funds, they already consist of these companies. 

Also, ESG funds are a nascent development, with limited options for now. They are yet to be proven especially considering their performance relative to other categories of funds. With a lack of track record, comparing ESG funds is also challenging. 

ESG scores lack consistency in rating funds, which makes it harder for an average investor to read between the lines. For example, ISS QualityScore gives a rating score from best to worst as 1 – 10, while the CDP Climate Score rating is from worst to best as 1 – 8. This rating system can be confusing for investors like you. You have to rely on the knowledge and discretion of fund managers. This may also expose you to the risk of greenwashing– a false representation of ESG adoption. 

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Conclusion: Should you include ESG funds in your portfolio? 

If you wish to include ESG funds in your portfolio, you should concentrate on the long-term potential. It may not be only about the returns but contributing to the well-being of the planet. Additionally, you need to account for your existing portfolio condition, investment avenues, asset allocation strategy, long-term needs, and ESG fund holdings. If you do decide on including ESG funds, do it after duly considering your goals, risk profile, and appropriate asset allocation ratio. 

(The author is Chief Business Officer, Scripbox. Views expressed above are personal)

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First published on: 11-12-2022 at 11:32 IST