ESG funds: Limited track record, but a well-diversified theme

The theme that involves investing in companies that adopt environment friendly policies, or bring in products or practices that influence society positively or have a demonstrated record of good governance is prevalent worldwide. The roll out of the Axis ESG Equity Fund has ignited the interest around the topic in India.

Sustainable investing refers to investing in a portfolio of stocks that are handpicked after assessing them on environmental (E), social (S) and governance (G) parameters – ESG.

Why Sustainable Investing?

Unlike most investment approaches, which focus only on returns, ESG investing focusses on managing risks. “Different companies may be exposed to different ESG risks depending on the nature of their business. There is an emphasis on assessing such material risks to sustainably generate wealth in the long run,” says Navneet Munot, CIO, SBI Funds Management.

For instance, depleting water resources may be a material risk for a paper company (Environmental risk) or increased instances of data theft could be a material risk to an IT or Financial company (Social risk). ESG investing recognises these non-financial risks and invests in companies that are equipped or gearing up to mitigate these risks, he adds.

“Companies that focus on their material sustainability are less risky compared to those companies which do not,” says Sivananth Ramachandran, Director, Capital Markets Policy India at CFA Institute.

Serious long-term investment vehicles such as pension funds are focussed on investing on ESG principles. According to Morningstar, globally, $2.96 trillion are invested in funds that are managed with ESG focus. ESG has been a popular theme in Europe, as more than 50 per cent of the investments are aligned to benchmark indices comprising of ESG friendly companies.

Is ESG investing possible in India?

In November 2019, the Securities Exchange Board of India (SEBI) made it mandatory for the top 1000 listed companies to prepare an annual business responsibility report (BRR). A BRR is a disclosure of adoption of responsible business practices by a listed company to all its stakeholders.

The Nifty 100 ESG TRI has 88 companies, spread across 16 sectors. Financial Services, IT, Consumer Goods, Energy and Automobile are the top five segments. Since its inception in March 2018, the Nifty 100 ESG TRI has delivered 11.46 per cent returns. During the same period, the Nifty 50 TRI index delivered 10.16 per cent. Nifty names such as Vedanta, Tata Steel, ITC and Maruti Suzuki do not figure in the Nifty 100 ESG.

Though the ESG index has outperformed, have thematic funds done well too?

There are two funds that invest in ESG-themed companies. SBI Magnum Equity ESG Fund (SBIESG, rolled out in May 2018; earlier called SBI Magnum Equity Fund) is one. Quantum India ESG (QESG) was launched in July 2019. SBIESG invests mostly in large cap stocks. QESG, however, has a multi-cap portfolio.

SBIESG has given 16.86 per cent returns over the past one year, while QESG has delivered 11.36 per cent over the past six months. The broader market S&P BSE 500 TRI delivered 12.61 and 10.84 per cent returns over past 12 and six months, respectively.

“Do not get carried away by the recent performance. This investment should be done for a long time frame and investors should be prepare to withstand intermittent periods of underperformance,” says Vishal Dhawan, founder and chief financial planner of Plan Ahead Wealth Advisors.

Axis Equity ESG Fund will invest 30 per cent of its corpus in stocks listed overseas and rest in India shares. “In addition to ESG backed sustainable growth investment opportunities available in India, investors will get access to businesses and themes with strong ESG practices that are not available in India,” says Ashwin Patni, head-products, Axis AMC.

Compared to developed countries, India has been a late entrant in this space. Many companies, predominantly in the large-cap space and some in the mid-cap segment, made ESG disclosures through their sustainability report. “As investors engage with companies and seek more ESG disclosures and regulations mandating BRR for top 1000 companies, we can expect the investment universe to surely increase,” says Chirag Mehta, senior fund manager, Quantum Asset Management Company. There are enough opportunities for investors in ESG space, Mehta added.

Should you invest in ESG funds?

“Unlike most other sectors and themes available in Indian stock markets, the ESG theme is well-diversified,” points out Vishal Dhawan.  He recommends restricting the allocation to 10 per cent of an equity portfolio.

Srikanth Bhagavat, managing director and principal advisor at Hexagon Capital Advisors recommends gradually enhancing allocation to ESG as the theme evolves and sufficient diversification is available.

There are just three mutual funds tracking the theme currently. ESG is an evolving theme worldwide, and in India it is at a nascent stage.

But if you invest in direct equities, you have enough options across large, mid and small-cap companies that confirm to ESG standards.