What are ESG Funds? Should You Invest in Them?

Introduction

Environmental, Social, and Governance funds or ESG funds, are a type of equity-oriented mutual fund scheme that became increasingly popular in the wake of the pandemic. ESG mutual funds invest in companies that are committed to corporate governance practices, social responsibility, and environmental conservation.

Currently, over 10 ESG funds in India help investors invest in companies that promote sustainable growth while offering decent returns on investment. Value-oriented investing is becoming increasingly popular in India, and ESG funds are expected to be popular investment opportunities in this space. So, before you start investing in them, let’s understand what are ESG funds, their types, their benefits, and how you can start investing.

What are ESG Funds?

Environmental, Social, and Governance funds (ESG funds) invest in companies that have a sustainable and holistic business approach. In India, ESG investing is synonymous with sustainable investing. Here is a breakdown of what each letter of ESG stands for:

Environmental: The ‘E’ of ESG focuses on the environmental impact of companies. This includes the carbon footprint of the company as well as the measures undertaken by the organisation to promote sustainability. Other factors like the use of eco-friendly energy sources, recycling measures, and waste disposal practices are also taken into account. 

Social: The ‘S’ of ESG focuses on the company’s treatment of its workforce. Various factors like gender equality, pay parity, and employee welfare are considered while also monitoring the participation of companies in relief and support of relevant social causes.

Governance: The ‘G’ of ESG focuses on corporate governance of the organisation. Compliance with government regulations and prompt grievance redressal facilities are crucial for companies to qualify as ESG companies. Whistleblower policies inside the corporation are also monitored and considered for the qualification of ESG companies

Types of ESG Mutual Funds

Before you get started with ESG investing, let’s check out the different types of ESG mutual fund schemes.

• Impact Funds: These funds invest in companies with a positive social and environmental impact while offering investors decent financial returns.
• Exclusionary Funds: Exclusionary funds, as the name suggests, do not limit companies where they can invest. They simply clearly define companies, industries, and sectors where they will not invest. Common examples of industries where exclusionary funds are not invested include tobacco, fossil fuels, or weapons/defence.
• Integration Funds: Integration funds are almost the opposite of exclusionary funds. These funds focus on integrating ESG factors into traditional investing. This allows the mutual fund houses to consider ESG factors alongside financial performance when choosing companies to invest in.
• Best-in-Class Funds: ESG funds invest in the companies with the best ESG ratings within any industry. These funds are expected to offer decent long-term financial returns to investors.
• Sustainable Objective Funds: Sustainable objective funds invest in infrastructure projects to meet specific sustainable development goals (SDGs).

Transition-Related Investments: These investments are aimed at helping energy transition towards net-zero carbon emissions. The investments are made in infrastructure projects and industries that help support this energy transition.

What are the Benefits of Investing in ESG Funds?

The increasing popularity of ESG funds goes to show how relevant and beneficial they are for sustainable growth. To help you get started investing in ESG funds, let’s review some of its top benefits.

• Value Alignment: Value-oriented investing is a good way for investors to support companies that share their personal values of sustainability and positive environmental impact. ESG funds allow investors to do the same. These funds prioritise ESG factors when choosing companies to invest in, and in the process, they allow investors to contribute to positive social and environmental change.
• Reduced Investment Risk: ESG factors do not only determine the sustainable practices undertaken by the company. One of the most important ESG factors is governance guidelines. Strict governance policies enforced internally, along with appropriate whistleblower protection policies, allow corporations to reduce the risk of corporate espionage or scandals. Investing in companies with robust governance policies helps investors keep their investments safe.
• Long-Term Performance: ESG funds invest in companies with a solid track record of sustainable practices, employee welfare, and robust governance policies. Studies have suggested that ESG-compliant companies financially outperform companies that do not follow these ESG standards. This allows ESG fund investors to potentially earn higher returns in the long term.

How to invest in ESG Funds?

To invest in ESG funds, you need only a mutual fund account with any AMC or online investment platform. Thanks to e-KYC verification processes, the entire process is online and can be completed very quickly. Here is a step-wise guide on how to get started investing in ESG funds.

• Step 1: Register an account with any reputed online investment platform like ShareKhan.
• Step 2: Complete e-KYC formalities to have your account ready for investing.
• Step 3: Find and compare ESG funds on the platform.
• Step 4: Make sure you take advantage of ShareKhan’s mutual fund recommendations.
• Step 5: Once you have finalised a fund that matches your investment goals, start investing in a lump sum or set up a SIP.

Should you invest in ESG Funds?

You should choose to invest in ESG mutual fund schemes if you are not a risk-averse investor and want to diversify your portfolio with value-oriented investing. That’s the short answer. To elaborate, there are various reasons why investing in ESG funds is a good opportunity for investors.

Apart from contributing to a sustainable future and value-oriented investing, ESG-compliant companies are less likely to face issues related to governance, employee welfare, and environmental management. When companies experience a crisis related to ESG factors, it can severely impact their stock market performance, which can yield losses for investors.

So, investing in companies that work hard to maintain a stable ESG rating ensures your investments will be safe and protected. This makes investing in ESG funds an intelligent move for investors.