Mar 3, 20213 min read

Sustainable investing is changing the financial landscape

Updated: Jun 15, 2023

Which are the mutual funds that are steering finance towards sustainability?

‘Green’, ‘sustainable’ & ‘eco-friendly’ are buzzwords which are bound to attract eyeballs from the youth. Major investment funds have noticed this and joined the sustainability bandwagon. Mutual funds have devised a way for small investors to earn healthy returns, without investing in fossil fuels, weapons or gambling - thanks to ESG funds!

Understanding ESG

Environmental, social & governance (ESG) funds operate like conventional mutual funds. You can invest a lump sum or periodic instalment of a minimum of Rs 500/- & then a professional fund manager will further invest this money in various companies to generate high returns. However, ESG funds are selective & invest only in those companies which comply with environmental norms & high standards of corporate governance. Instead of waiting for governments to de-incentivise investments in polluting industries, small investors can use ESG funds as a tactic to simply withhold their money from companies indulging in questionable business practices.

(Also read: Mean Green Investing Machine: Greenwashing in ESG Funds)

Decoding the ESG Matrix

A fund will create an ESG matrix and evaluate companies against this. For example:

Environmental, social, and governance matrix

Each company will be assigned a score based on these parameters and companies scoring below a certain level will be eliminated from the fund’s selection.

Global Impact

Despite the big sell-off last March due to Covid-19 spooking the economy, sustainable funds ended the first quarter of 2020 with net sales of $38.8 bn globally compared with outflows of $373 bn for all long-term mutual funds, according to Morningstar. In simple words, investors fled mutual funds apart from one sector: sustainable investing.

In 2020, BlackRock Inc, the biggest money manager on the planet, introduced nearly a hundred new ESG funds. Larry Fink, chief executive officer of BlackRock Inc; issued a stern warning to CEOs. He told them, in effect, that if they don’t start paying more attention to climate change, their businesses, their communities and the economy will face dire consequences. With the U.S. experiencing an energy crisis that has left millions without power amid extreme cold, his message is likely to have renewed resonance.

Investing Strategy

With Wall Street being notorious for putting profits first, many will be wary of whether ESG funds are simply a greenwashing tactic. ESG isn’t just about values or promoting change. It’s a quantitative strategy theorising that companies with fewer environmental, social and governance risks have a less volatile or better-performing stock, or both.

For example, British Petroleum’s 2010 oil spill & Volkswagen’s 2015 emission scandal caused billions of dollars in losses to investors. This could have been avoided with an ESG strategy.

(Also read: The Red Flags of Green Investment)

ESG funds in India

While the Indian ESG funds space is still in a nascent stage, its quickly picking up pace with five new funds launched in 2020. Aditya Birla, Axis and Kotak are some of the leading fund houses that have launched ESG schemes. However, due to a lack of regulation by SEBI (the market regulator), the fund houses currently don’t have standardised parameters to evaluate companies from an ESG perspective.

Analysing fund returns in comparison to traditional equity investments

Let’s do a quick quantitative analysis of the performance of these Indian ESG funds.

Ideally, mutual fund performance should be evaluated over 3 years or more, but since ESG funds are a relatively new phenomenon in India, we’ll assess the fund performance of all funds which are over a year old.

*Note: The table below indicates historic annualised returns.

If you have invested Rs 100 at the beginning of the year & you earn an annualised return of 17%, you’ll have Rs (100+17) = Rs 117 at the end of the year. Similarly, an annualised return of 17% p.a. over 5 years means that your investment increased by 17% each year over the five-year period.

Thus, SBI Magnum marginally outperformed the general market over the three-year and seven-year periods. All funds gave stellar returns in a one-year period in line with the good performance of the general market as well.

Essentially, your decision to invest in mutual funds depends on your risk appetite. But, ESG funds offer an option to ensure your money is put to use in an ethical and accountable manner. ESG funds may not drastically outperform the market, but past performance indicates strong returns. These funds encourage a subtle push towards greener business practices & higher standards of corporate governance. Although these funds are in a nascent stage, they can be genuine tools of change as a part of conscientious capitalism.