What are ESG mutual funds in India and should you invest in them in 2025?

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ESG funds sounded like the next big shift in investing when they entered the Indian market a few years ago. The idea was simple: invest only in companies that score well on environmental, social and governance standards. In theory, this meant cleaner businesses, better ethics, stronger boards and more transparent corporate behaviour. For investors, it promised the comfort of earning returns without supporting companies that damage ecosystems or ignore social responsibility.

But the Indian experience with ESG has been mixed. A handful of schemes now operate in this category, disclosures have improved, global flows have slowed, and regulators have questioned the reliability of ESG ratings. To decide whether these funds fit into your investment plan, it helps to understand what ESG really means today rather than what it promised when it launched.

ESG funds select companies using three broad lenses. The ‘E’ looks at environmental factors like carbon emissions, water use or waste management. The ‘S’ looks at labour standards, diversity, community impact and product safety. The ‘G’ examines corporate governance, including board structures, shareholder rights and transparency. Fund managers use publicly available data and third-party ESG scores to build a portfolio that tries to avoid companies with poor compliance or high risks related to climate rules, regulatory action or reputation. Ideally, this should deliver fewer shocks, better long-term resilience and a cleaner reputation profile.

One of the biggest complications is that ESG ratings are far from standardised. The same company can receive a very high score from one rating provider and a low score from another because methodology and weightage differ widely. In India, where disclosures around sustainability and social practices are still evolving, ratings can feel incomplete or outdated. This inconsistency trickles down into fund portfolios, making it harder for investors to know what they are

actually buying.

Regulators have already flagged this lack of uniformity. They have pushed for clearer disclosures, more reliable data and guidelines on how ESG funds should present their investment strategy. This is work in progress, and the industry is still adjusting.

In the early years, ESG funds attracted interest because they held large, high-quality companies that were already seen as market leaders. When markets favoured these sectors, ESG funds kept pace or even outperformed. But the performance trend has not been consistently superior. In phases where cyclical, commodity-heavy or carbon-intensive sectors rallied, ESG funds lagged because they had very little exposure to those stocks. This does not make ESG a “bad” category; it simply means performance is tied to the type of companies it prefers. Investors expecting automatic outperformance may be disappointed, while those who prefer stability and governance quality may still find comfort in the approach.

ESG funds can work for investors who care about long-term corporate behaviour, want a cleaner portfolio or prefer companies with fewer governance surprises. They also suit investors who already have a diversified portfolio and want to dedicate a small portion to ethically aligned investing.

However, ESG funds should not be your primary equity allocation. The universe of eligible companies is still narrow. Ratings are inconsistent. And performance can lag in certain market trends. A broad, diversified equity fund is still a better core holding. ESG funds make sense only if you see them as a thematic or satellite allocation— not a replacement for your main equity exposure.

A reasonable use-case is to treat ESG as a 5-10 percent optional allocation within your equity portfolio if you genuinely value the theme. It adds a layer of ethical preference and exposes you to companies that tend to have better governance practices. But you should not expect it to consistently beat the market or reduce volatility. If your goal is simply long-term returns without thematic constraints, a diversified flexi-cap or large-cap fund remains the simpler choice.

ESG mutual funds carry a thoughtful idea but still operate in an evolving ecosystem. They can complement a portfolio, not define it. As disclosures improve and rating systems get more uniform, the category may mature further. Until then, invest only if the philosophy matters to you, keep your expectations realistic and treat ESG as an add-on rather than the centrepiece of your equity

strategy.