Things You Need to Know Before Investing in ESG Funds

Description

The philosophies of investment and sustainability are quite similar, as both think in terms of the future. If you aim to invest in companies that follow sustainable practices, ESG funds are the way to go.

What are ESG funds?

The worlds of investment and sustainability might seem like they have nothing to do with each other, but recent climate trends have forced them to collide. Typically, the process of making an investment involves vetting the fund or company based on factors like business model, historical performance, annual reports, and so on. However, in this day and age, investors have started considering some additional fundamentals, namely Environmental, Social, and Governance. These three aspects combined form the basis of a new class of mutual funds called ESG funds. So, take let’s take a look at what they are.

In simple words, an ESG mutual fund focuses not only on a company's financial performance, but on how it functions as a part of society. Common questions an ESG fund might ask before investing include: what does the company manufacture? Is it committed to Corporate Social Responsibility (CSR)? Based on this, companies that manufacture products viewed as harmful to environmental or societal health are ruled out, such as alcohol, tobacco, etc.

Therefore, ESG-compliant companies include those that are performing well not only in terms of finance, but also in the environment, society, and governance. Environmental factors would entail the organization’s greenhouse gas emissions, sustainability of their business model, use of renewable resources, and the like. In a similar vein, the social criteria would involve their treatment of employees, attitude towards work-life balance, equal opportunities for people regardless of gender or religion, etc. Lastly, the governance factor refers to how diverse the company’s leadership is and their sensitivity to shareholders.

Factors to Consider before Investing in ESG Funds

Now that you’re all caught up on finding out more about an ESG fund, you might wonder if it’s a good idea to invest in it. Before you decide, here are a few things you should consider:

1. Profitability

Ideally, you would want the company you invest in to have some, if not all, the abovementioned attributes, you also want to ensure that it is profitable. Contrary to popular belief, an ESG fund is not the same as charity. In fact, it’s like any other mutual fund – that is, focused heavily on returns along with sustainability. According to Value Research, the Nifty 100 ESG Index has generated average returns of 10.9% since inception, and the figure is only expanding.

2. Sustainability

Climate change has been one of the most-talked-about subjects of the decade around the world. We live in a time when companies must think about sustainable business models, and investors must carefully consider the kind of organisations they support. By helping the growth of ethical companies that follow practices that favour sustainability, you make a difference to the planet's future. This is what an ESG mutual fund measures. It’s an opportunity to work towards the betterment of society at large without compromising on your financial goals.

3. Diversification

One of the thumb rules of investment is diversifying your portfolio because it helps in navigating the market’s volatility. However, when it comes to ESG funds, this rule is difficult to abide by.

ESG companies have generally been large-cap stocks, which means you might miss the opportunity to invest in mid-cap and small-cap stocks. The funds, by nature, also exclude several large sectors with great earnings potential. So, your choice while selecting funds narrows and exposes you to greater risk than a diversified portfolio does.

Additional Read: 7 Reasons to Invest in Mutual Funds

Conclusion

It’s worth noting that ESG mutual funds are a relatively new concept, and there isn’t enough data to offer accurate assessments of their performance over time in the Indian markets. However, the human conscience plays a critical role in the decision to invest in an ESG fund. There’s no doubt that socially responsible enterprises are the future and investing in them is an ethical alternative, but how these funds perform in the long run is yet to be seen.

Also Read: Different Ways to Invest in Mutual Funds

Disclaimer:

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