The ESG (Environment, social and governance) funds are thematic funds that invest in socially responsible companies which fulfil their responsibilities towards environment and social causes, and also follow high ideals of corporate governance. These funds are distinct from other funds in a fundamental way. Mutual funds are constituted to earn gains while keeping a low risk, the ESG funds are made with a very different benchmark in mind i.e. the commitment of companies towards society, environment and ethical governance.
So, a company that sells liquor or cigarettes, or which has serious complaints of fraud filed against it will not draw investment from ESG funds regardless of its earning potential.
To be able to understand these in detail, let us understand each of the three factors one by one:
Environment: Environmental concerns include the commitment of the company towards waste disposal, reducing carbon footprint and an emphasis on conservation of energy.
Social: This revolves around taking actions to stand true to the social ethos and being a responsible institution of society by fulfilling its obligation towards gender justice, equality and welfare of employees.
Governance: This pertains to good corporate governance practice by adhering to regulatory compliances, and putting such systems in place as grievance redressal and internal mechanisms to prevent financial impropriety.
Features of ESG funds:
1. The funds are thematic and invest in companies that are committed to environment and social causes, and adhere to high corporate governance.
2. These funds have limited options in terms of sectors and companies they can invest in.
3. These are newer funds in India. So, not too many funds will have a performance record to demonstrate.
4. Companies that can give high returns but do not fall under the category of ESG cannot be part of the fund.
5. These funds do not cater to the investors looking for high returns but to those investors who want to do their bit for the environment and society.
The companies are judged for their ESG commitment based on the ESG score given by the research agencies such as MSCI and Morning Star.
MSCI, for instance, divides companies into three broad categories – Leader, average and laggard starting from CCC to AAA – with AAA the best score.
A company falling in the category of leader is the one that leads the industry in managing its ESG risks. Likewise, average rating is given to a company that has a moderate track record of managing the ESG risks in comparison to its contemporaries in the industry. On the other side of the spectrum, a company that lags behind its peers in managing ESG risks is put in the category of laggard.
At the same time, Morning Star’s ESG score is divided into five broad ratings based on how small or big the risk is – negligible, low, medium, high and severe. The companies with a score of 0-9.99 are put in the category of negligible ESG risk. 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.
Aside from these research organisations, every fund has its own benchmarks to gauge a company’s ESG score based on which it decides the sectors and companies to invest into.
Some prominent ESG funds include Aditya Birla Sun Life ESG Fund, SBI Magnum Equity ESG Fund, Axis ESG Equity Fund and ICICI Prudential ESG Fund.
Conclusion: Although investment in ESG funds is seen as an effort by socially conscious citizens to be responsible investors, some experts believe that these funds have a limited upside because of a restricted number of stocks and sectors that can be invested into.