The Rise of Sustainable Investing: ESG in Mutual Funds

The COVID-19 pandemic reshaped people's thinking about investing, increasing interest in responsible and sustainable choices. As investors seek to align their portfolios with environmental, social, and governance (ESG) principles, Asia has witnessed a growing demand for ESG funds. While challenges like greenwashing remain, the momentum is undeniable.

In India, ESG investing is still in its early stages, but its rise in recent years signals a shift toward a more conscious and future-focused investment landscape. So, what's driving this change, and what does it mean for investors? Let's explore.

Investing in ESG (Environmental, Social, and Governance) funds is gaining traction globally, but the decision to invest now depends on several factors. 2025 ESG regulations will be tested in Europe, while the U.S. faces policy reversals. Despite these challenges, ESG assets are projected to grow significantly, with over 50% of professionally managed investments expected to be ESG by 2025. In India, sustainable finance is also rising, driven by increasing awareness and regulatory support.

Investors should be cautious of greenwashing risks and ensure that funds align with their values and financial goals. With the global focus on climate action and sustainability, ESG funds offer a promising avenue for socially responsible investing, but thorough research is essential before making a decision.

As ESG (Environmental, Social, and Governance) investing gains traction in India, several ESG-focused funds are emerging as preferred choices for sustainable investors. These funds prioritize companies demonstrating strong ESG practices, ensuring responsible investment while delivering financial returns. Below is a detailed look at the top ESG funds in India, their performance, key holdings, and unique attributes.

The Securities and Exchange Board of India (SEBI) added a dedicated sub-category for Environmental, Social, and Governance (ESG) investments to the equity scheme thematic category in July 2023. Mutual funds can start multiple ESG-focused schemes under this initiative. Each scheme will follow one of the six different strategies below:

• Exclusion: This strategy involves excluding securities based on specific ESG-related activities, business practices, or sectors. For instance, a fund might avoid investing in companies involved in tobacco production or those with significant environmental controversies.
• Integration: Funds adopting this approach incorporate ESG factors that are material to the investment's risk and return, alongside traditional financial metrics, during the decision-making process.
• Best-in-Class & Positive Screening: This strategy focuses on investing in companies that outperform their peers on specific ESG performance metrics. For example, a fund may select top-performing firms in renewable energy adoption within a particular industry.
• Impact Investing: Funds with this strategy aim to generate measurable positive social or environmental impacts alongside financial returns. They invest in projects or companies with clear objectives, such as affordable housing or sustainable agriculture, and assess the real-world effects of their investments.
• Sustainable Objectives: These funds invest in sectors, industries, or companies poised to benefit from long-term ESG-related trends, such as clean energy, water conservation, or sustainable infrastructure.
• Transition or Transition-Related Investments: This strategy targets companies facilitating environmental transitions, including reducing carbon emissions or developing technologies supporting a shift towards a more sustainable economy.

SEBI mandates that a minimum of 80% of the total assets under management (AUM) in ESG schemes be invested in equity and equity-related instruments aligned with the chosen strategy. The remaining portion must not contradict the scheme's stated strategy. Additionally, at least 65% of the AUM should be allocated to companies that provide full Business Responsibility and Sustainability Reporting (BRSR) with assurance on BRSR Core disclosures.

• Short-Term Capital Gains (STCG): 20% tax if sold within 1 year.
• Long-Term Capital Gains (LTCG): 12.5% tax if held over 1 year (₹1.25 lakh exemption per year).
• Dividends: Taxed per your income slab, with 10% TDS if above ₹5,000.
• Securities Transaction Tax (STT): 0.001% on the sale of ESG fund units.
• No Tax-Saving ESG Funds: Unlike ELSS, ESG funds don't offer 80C tax benefits.

1. 1. Fund's ESG Strategy: Check if the fund follows exclusion, integration, impact investing, or another ESG approach.
2. 2. Performance vs. Traditional Funds: Compare past returns with regular equity funds to ensure competitive growth.
3. 3. Fund Manager's Expertise: Look at the experience and track record of the fund manager in ESG investing.
4. 4. ESG Ratings & Transparency: Verify if the fund uses credible ESG ratings and follows SEBI's BRSR Core reporting guidelines.
5. 5. Expense Ratio: ESG funds may have higher fees; check if the expense ratio justifies potential returns.
6. 6. Taxation: ESG funds are taxed like equity funds (20% STCG, 12.5% LTCG after ₹1.25 lakh exemption).
7. 7. Diversification: Ensure the fund has a balanced sector allocation and is not overly focused on one industry.
8. 8. Regulatory Compliance: Ensure the fund follows SEBI's latest ESG norms to avoid greenwashing risks.
9. 9. Investment Horizon: ESG funds work best for long-term investors due to potential market fluctuations.
10. 10. Personal Values: Align your ESG investment with causes you genuinely support (e.g., clean energy, ethical labor).

Investing in an Environmental, Social, and Governance (ESG) fund can align your financial goals with sustainable and ethical investing principles. Here are some key reasons why you should consider investing in an ESG fund:

Sustainable and Ethical Investing:
ESG funds focus on companies that follow responsible business practices, such as reducing carbon footprints, maintaining fair labor policies, and ensuring corporate transparency. By investing in these funds, you support businesses that contribute positively to society and the environment.

Long-Term Financial Returns:
Many ESG-focused companies are leaders in innovation, risk management, and sustainability, which can translate into strong long-term financial performance. Studies show that ESG investments often match or even outperform traditional investments over time.

Risk Mitigation:
Companies with poor environmental, social, or governance practices face higher risks, such as regulatory fines, lawsuits, and reputational damage. ESG funds tend to invest in companies with better risk management, reducing the chances of severe financial setbacks.

Regulatory and Policy Support:
Governments and regulatory bodies are increasingly promoting sustainability initiatives, including tax incentives and stricter regulations on pollution and corporate governance. ESG investments may benefit from favorable policies and future growth opportunities.

Growing Investor Demand:
There is a rising trend among institutional and retail investors to allocate funds toward sustainable investments. This increased demand can drive higher valuations for ESG-compliant companies, creating strong growth potential for ESG funds.

Social Impact and Corporate Responsibility:
Investing in ESG funds allows you to contribute to positive change, whether it’s supporting companies that focus on renewable energy, ethical labor practices, or corporate diversity. Your investment can drive companies to prioritize sustainability and ethical governance.

Diversification Opportunities:
Many ESG funds invest in a variety of sectors, such as clean energy, technology, and healthcare, offering strong diversification benefits. This can help balance your investment portfolio and provide resilience against market volatility.

Transparency and Accountability:
ESG funds often undergo strict screening and reporting, ensuring that your investment is supporting genuinely responsible companies. Many funds provide ESG ratings and reports to keep investors informed.

Investing in an ESG fund is not just about financial returns. It’s also about making a difference. With increasing global awareness of sustainability and ethical investing, ESG funds provide an opportunity to grow your wealth while contributing to a better future.

People are changing the way they invest in a big way with ESG investing. People can make their money grow in a way that fits with their values by investing in ESG funds. This helps create a more sustainable and moral future. With the increasing global focus on sustainability and responsible investing, now is the perfect time to explore ESG mutual funds.

Research carefully and get professional advice to get the most out of your investment. If you are waiting for the right investment advisor, you can find the right one from our latest updated mutual fund distributor profiles from PAN India. Don't wait today to light up your tomorrow. Make your future safe for everyone.