What are ESG bonds and why should you invest in them?

The capital markets regulator Securities Exchange Board of India (Sebi) recently defined a path for top 150 firms, as per the market capitalisation, to the ESG framework. The regulator asked for reasonable assurance of Core business responsibility and sustainability reporting (BRSR). This is seen as a novel ESG framework.

For the unversed, BRSR Core mandates 49 key parameters for ESG reporting, under which objective disclosures are made along the lines of environment, social causes and corporate governance. This enables an assessment of firms across sectors and industries.

This move is seen as a key step to strengthening ESG framework and as an impetus to fresh investment in environmentally and socially conscious companies.

This brings to focus the growing popularity of companies that are high on the ESG scale. There are a number of mutual funds that invest in companies based on their commitment to the factors of environment, social consciousness and corporate governance.

Features of ESG funds

1 These are thematic mutual funds which invest in those companies that have demonstrable commitment to environment, social causes and governance.

2. These are quite new in India and there are not many options for the investors which are exploring to invest in this category of funds, for example SBI Magnum Equity ESG Fund (Growth).

3. These funds are not meant for investors who are particularly aiming to maximise their returns since the objective of these funds is not to increase their returns but to make investment in the companies which are high on ESG score.

4. ESG funds cannot invest in the companies that are low on ESG, even if they are delivering high returns to their shareholders. For example, a company that makes cigarettes or which has been accused of a large financial fraud in the past can not make it to an ESG fund's portfolio.

ESG score

There are two rating agencies that give ESG scores to companies. These scores come handy for the mutual funds before they take a call on the companies to invest or not.

The ESG score is given by MSCI and MorningStar. The former has classified companies into three categories on the basis of their ESG score. These are as follows:

Leader: These are the companies that are leaders in managing the ESG risk.

Average: These organisations have a moderate track record of managing ESG risk.

Laggard: At the bottom are these companies, which are laggards in managing their ESG risk.

Morningstar, on the other hand, has categorised five types of ESG rating on the basis of risk these companies undertake.

Negligible: This score is given to the companies with negligible ESG risk

Low: This means the company has very low ESG risk

Medium: These companies have an average risk to their commitment to environment, social causes and governance.

High: It refers to the companies with high ESG risk.

Severe: These are the companies with acute ESG risk i.e., their risk is profound.

Those between 10-19.99 are given ‘low’ ESG score, between 20 to 29.99 come under ‘medium’ score, between 30-39.99 are part of ‘high’ ESG score and any organisation with 40+ score has ‘severe’ ESG risk.