When you set out to look for a company to invest in, the financial robustness of the company is of great significance to you. And rightly so. Financially, it makes little sense to invest in a company whose financials are weak, whose sales growth is poor and/or whose business prospects are not promising.
However, non-financial considerations are becoming increasingly important for investors. The public image of the company, its governance, and its stance on environmental and social issues are being deeply scrutinized by sections of investors. This explains the emergence of ESG investing.
Environmental, Social and Governance (ESG) based investing is getting global recognition. These criteria influence the long-term sustainability of the company, and has an eventual effect on its financial performance as well.
The Securities and Exchange Board of India (SEBI) has renewed its commitment towards sustainable investing by announcing several measures recently. Prominent among these measures is that fund houses can now offer more than one ESG-based fund scheme. Until now, mutual fund companies have been allowed to offer only one ESG-based fund scheme. ESG-based mutual funds fall under the thematic fund category.
As per the SEBI guidelines, it is now mandatory for AMCs to allocate at least 65% of the ESG-based fund capital to companies that fulfill the assurance compliance under the Business Responsibility and Sustainability Report (BRSR). Notably, in May 2021, SEBI issued a circular to all listed entities in India mentioning that the top 1000 companies by market capitalization will mandatorily file this report from the financial year 2022-23. The recent guidelines are a continuation of SEBI’s efforts of mainstreaming ESG into corporate governance in India.
The fund houses are also required to comply with a few requirements when it comes to ESG-based funds.
It can be assumed that investors will now have more information to refer to while selecting an ESG-based scheme. The workings of ESG-based schemes will become more transparent with the implementation of these guidelines.
Apart from the environmental and societal aspects, the governance angle in ESG investing is closely linked with the future viability and sustainability of businesses. Instances of corporate misgovernance have emerged time and again in the Indian economy. In the recent past, the misrepresentation of information by Satyam rocked the stock market. A decade later in 2018, IL&FS was found to be involved in accounting fraud, thus unmasking the soft underbelly of the credit market. Recently, American firm Hindenburg accused the Adani group of market manipulation which resulted in most Adani stocks hitting rock bottom. Many banking stocks too faced the heat during that period. While we hope that the Adani ship gets steadied for the sake of the Indian economy, spotting the early warning signs is important in protecting the finances of the retail investor.
Corporate misgovernance has been the root cause of many stock market disasters. In all of them, it is the retail investors who end up being the worst hit. The ESG framework can reduce portfolio risk by identifying and investing in stocks with a focus on long-term sustainability.
Given the present cap of one ESG fund per fund house, there are only a few ESG funds in India. Of the 8 ESG mutual funds reviewed by us, all had equity investments of 95% or more, and are therefore actively- managed funds. Most of these funds have a high expense ratio (2% or more) with Mirae Asset Nifty 100 ESG having the lowest at 1.15%.
SBI Magnum Equity ESG fund is the oldest of the lot and has the highest asset under management of over Rs 4,456 crores. Quantum India ESG has the highest 3-year CAGR of 26% and the highest to-date CAGR of 13.3%. Most of these fund schemes have three or fewer years of track record, except for the SBI Magnum Equity ESG fund which has a 10-year CAGR of 12.88%.
An ESG mutual fund portfolio typically comprises stocks from all sectors and across market capitalization. Companies from the banking and IT sectors appear prominently in these portfolios, with most of them being large-cap companies. Being guided by ESG norms, stocks representing products like gambling, liquor and tobacco rarely feature in an ESG mutual fund portfolio.
For an investor, identifying governance issues and unethical practices in companies may not be possible at an individual level. ESG investing acts as a filter through which fund managers cherry-pick stocks that hold good long-term value propositions. The recent SEBI guidelines will further encourage investors to add this fund category as a part of their portfolio.
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