ESG mutual funds: All set for higher inflows and greater investor interest

Image: Shutterstock

ESG is the buzzword in the financial markets in 2021. ESG or Environment, Social and Governance parameters are used by the new generation of investors for judging companies and choosing where to put their money. In other words, today’s investor prefers to invest in companies that act responsibly towards the environment and the community in which they function, while ensuring ethical governance within their corporate structures.

The COVID-19 pandemic has given a big push to the ESG theme. There has been a shift in investor values and sentiments towards socially responsible investing (SRI) and impact investing. In addition, there has been a greater focus on climate change and its impact on our lives worldwide, leading to the theme of “conscious investing” gaining traction in 2021.

Data from the global fund-flow tracker, EPFR, revealed that equity funds that offered SRI or ESG investing saw record inflows of $168.74 billion in 2020, a huge jump from the $63.35 billion seen in 2019. In addition, a BlackRock survey in December 2020, conducted on 425 investors across 27 countries representing an estimated $25 trillion in assets under management (AUM), revealed that investors plan to double their ESG investments over the next five years. This would take the ESG AUM from 18 percent in 2020 to 37 percent by 2025.

As of early 2021, about $2.96 trillion had been invested globally with an ESG focus. Europe leads in terms of growth in sustainable assets, followed by the Americas and Asia Pacific.

ESG Investing in India

The MSCI 2021 Global Institutional Investor survey revealed that about 79 percent of investors in Asia meaningfully raised their investments in ESG funds in the latter half of 2020, allocating more than $5 billion in these funds. The total ESG-focused investments in the region totalled $25.4 billion, representing an almost 131 percent rise from the 2019 levels.

ESG assets in India have grown at 22 percent a year ever since their launch in 2006, when the Principles of Responsible Investing (PRI) network was established. The Nifty 100 ESG Index has specifically been designed to track the performance of companies on the Nifty 100 based on ESG scores. This index has outperformed its parent, Nifty 100, across multiple timeframes. The Nifty 100 ESG Index also outperformed the Nifty 50, generating higher five-year returns in 2020.

To capitalise on this trend, Indian mutual funds have rolled out new ESG-based offerings. Till 2019, there were only a couple of ESG-focused mutual funds in India. But in 2020, six ESG funds were launched by some of the largest companies, including Aditya Birla Sun Life, Axis Mutual Fund and ICICI Prudential. By March 2021, net inflows into these funds were close to ₹678 crore, compared to a mere ₹68 crore in March 2020.

Investor interest has also been piqued by Indian giants such as Reliance, Tata and Adani announcing their green plans. For instance, Reliance intends to achieve net-zero carbon emissions by 2035 and has allocated ₹75,000 crore towards this goal.

Benefits of ESG Investing

For investors, ESG investing can decrease downside risks, as compared to traditional investments. Some analysts also say that better ESG ratings can improve the P/E (price earnings) ratio for companies in the future. Also, with rising demand for ESG funds, the expense ratio will get normalized, which had initially been considered a limiting factor in such investments.

More importantly, ESG-focused investments have been delivering higher returns for investors in India. In fact, the Nifty ESG Index generated five-year returns of 10.80 percent CAGR, as of October 30, 2020, compared to the 8.99 percent of the Nifty 50. Of course, given that different ESG funds might have different investment methodologies, the returns will vary from one fund to another.

India’s push for sustainable development goals (SDGs) feeds right into this. The nation is committed to the UNO's SDGs, with the NITI Aayog having detailed 17 SDGs and formulated a Sustainable Development Framework (SDF), in collaboration with the UNO, for 2018–2022.

In addition, in 2020, SEBI made Business and Responsibility Reporting mandatory from 2023 onwards for the top 1,000 companies listed on the Indian stock exchange. Such reporting, therefore, remains voluntary till 2022. Despite this, four out of five companies on the Nifty also release public disclosures regarding their ESG practices. What’s more, 41 out of 50 companies even provide detailed ESG reports. This underlines the rising importance of such practices in the minds of investors.

In conclusion, ESG investment is a win-win for both businesses and investors. Better ESG ratings have a positive impact on stock performance, which is great for all stakeholders.