Should You Invest In ESG Funds?

While Norway stands out as a classic example of environmental, social and governance (ESG)- driven divestment through its sovereign wealth fund exiting investments in major oil, coal and mining companies, the scenario in India has been lagging behind with investor interest in ESG-promoting companies still to match the world standards. The article takes an overview of what ESG investing stands for and how it may shape up in the years to come [EasyDNNnews:PaidContentStart]

Imagine you are a young investor, eager to build a portfolio that not only aims for financial growth but also aligns with your values—your sense of responsibility to leave a positive legacy for future generations. You want to invest in companies that prioritise their impact on the world— businesses that actively reduce carbon emissions, champion fair labour practices and uphold transparent governance. This is where ESG investing comes in. ESG, or environmental, social and governance investing, enables investors like you to make financial decisions that reflect a commitment to sustainability and ethics. 

It’s about more than just returns. It’s about supporting companies making a positive difference. In a world increasingly shaped by climate change, social challenges and ethical issues, ESG investing is a movement with the power to reshape finance and steer capital towards companies prioritising people, planet and principles. A classic example of ESG-driven divestment is Norway’s sovereign wealth fund exiting investments in major oil, coal and mining companies. Known as the Government Pension Fund Global (GPFG), Norway’s fund is one of the world’s largest, managing over USD 1.74 trillion currently 

In 2019, it announced its exit from several companies deemed unsustainable, reflecting a commitment to responsible investing. A significant part of this decision was to divest from companies generating over 30 per cent of their revenue from coal. This meant divesting from major coal companies like Glencore and Anglo American due to their environmental impact, with coal being one of the biggest contributors to greenhouse gas emissions. Norway’s decision wasn’t just financial. 

It reflected a national commitment to sustainability and climate goals. As a leader in sustainability, Norway emphasises that its wealth fund investments align with its environmental priorities. This exit made waves in the market, with Norway’s fund often seen as a bellwether for other global institutional investors. This move showcased the power of ESG concerns in major investment decisions, signalling that even profitable sectors like coal and oil could lose favour if they don’t align with ESG values. ESG investing reflects a growing movement among investors aligning with businesses dedicated to ethical and sustainable growth. 

This approach goes beyond traditional financial metrics, assessing companies on climate risk, community impact, diversity and ethical management. By focusing on these aspects,ESG investing fosters long-term sustainability and drives positive change, benefiting society and shareholders alike. From niche interest to a core pillar of global finance, ESG investing now guides how capital is allocated and how companies operate. Investors worldwide are increasingly seeking portfolios that meet sustainable and ethical standards, making ESG principles a powerful force in financial markets. 

And so, what is the impact? It has resulted in a surge in green bonds, sustainable funds and socially responsible investments. At the close of 2023, the total assets under management (AUM) of the world’s 500 largest asset managers reached USD 128 trillion, with approximately 2.3 per cent allocated to sustainable or ESG funds, amounting to USD 3 trillion. By 2030, ESG assets are projected to surpass USD 40 trillion, potentially making up over 25 per cent of the global AUM, underscoring strong growth in ESG investments as investor interest and commitment to sustainable practices rise. 

Evolution and AUM of ESG Funds in India
The journey of ESG funds in India began with the transformation of the SBI Magnum Equity Fund into the SBI Magnum Equity ESG Fund in May 2018, marking the launch of the country’s first ESG-focused mutual fund. This shift was a significant milestone, reflecting rising investor demand for socially responsible investment options. In 2020, the trend gained momentum with major asset management companies like Axis, ICICI Prudential and Aditya Birla Sun Life launching their ESG funds, aligning their strategies with global sustainability trends. 

These funds catered to an increasingly aware investor base, focusing on companies that emphasised ethical governance, environmental responsibility and positive social impact. Regulatory support from bodies such as the Securities and Exchange Board of India (SEBI), which stressed the importance of ESG disclosures, further fuelled the development of ESG funds. Additionally, the strong performance of ESG funds (calendar year performance), represented by the Nifty 100 Enhanced ESG index, during the corona virus pandemic both in India and abroad, encouraged more mutual fund companies to introduce ESG-focused options. 

However, the momentum of new ESG fund launches has slowed dramatically over the past two years. By September 2024, there were nine ESG mutual funds and one ETF in the Indian market, collectively managing approximately ₹11,189 crore in assets under management (AUM), up from ₹9,879.36 crore the previous year—a modest growth of 13.25 per cent. In contrast, the broader equity market, represented by the Nifty 500, rose by 32 per cent over the same period. ESG funds have struggled to gain significant traction in the Indian mutual fund industry, as reflected in their comparatively stagnant AUM. While the AUM of India’s overall mutual fund industry has more than doubled in recent years, dedicated ESG funds have shown flat or minimal growth. 

As of the quarter ending December 2022, ESG fund AUM in India stood at ₹11,074.36 crore, distributed across eight equity schemes, one exchange-traded fund (ETF) and one fund of funds (FoF) scheme, as reported by the Association of Mutual Funds in India (AMFI). This sector initially saw robust growth, rising from ₹9,914.16 crore in March 2021 to ₹12,686.32 crore by December 2021. However, by June 2022, the AUM had slightly declined to ₹10,970.17 crore, underscoring the inconsistent growth trajectory of ESG funds in the Indian market. 

Performance of ESG Funds


The performance analysis of ESG funds shows that, despite positive returns, they tend to underperform when compared to other fund categories, particularly over extended periods. For example, while ESG funds posted a 35.48 per cent one-year return, they lagged behind categories like Mid-Cap (46.05 per cent) and value (42.99 per cent). Over a three-year horizon, the thematic ESG category posted a return of 12.91 per cent, lower than categories like Small-Cap (23.15 per cent), mid-cap (21.15 per cent) and value (19.77 per cent). 

One reason for this underperformance is the restrictive nature of ESG mandates, which limit exposure to certain highperforming sectors such as fossil fuels or certain manufacturing sectors that other funds capitalise on. In India, and unlike their European or US counterparts, they have not seen the same robust inflows. With a preference shift towards mid-cap and small-cap funds, which have delivered superior returns in recent years, investor interest in ESG has waned. Additionally, the regulatory framework for ESG in India restricts these funds to mainly Large-Cap companies with strong ESG disclosures. 

This limits their ability to diversify into high-growth, mid-cap and small-cap stocks. This restriction has narrowed the investment universe and hindered returns, especially in a market where manufacturing and energy sectors—typically with lower ESG ratings—have outperformed financial and IT sectors, which dominate ESG portfolios. 

To get a deeper understanding of the performance of ESG funds, we analysed the performance of Nifty 100 ESG Sector Leaders index, which aims to track the performance of select companies within each sector of the Nifty 100 which have scored well on the management of ESG risk and which do not have involvement in any major controversies. These companies mostly form part of the ESG funds. We compared its performance with Nifty 100. The following table shows the comparison of the performance statistics on various parameters of both the indices. 

The comparison highlights that the Nifty 100 Enhanced ESG index achieved a higher total return (112.21 per cent versus 105.10 per cent) and CAGR (16.84 per cent versus 16.02 per cent) over the observed period, suggesting slightly better long-term performance than the broader Nifty 100. Although the ESG index has a marginally higher daily Sharpe ratio (0.93 versus 0.89), its yearly Sharpe ratio (1.06 versus 1.73) and higher volatility (14.8 per cent versus 9.17 per cent) indicate that it takes on more risk for comparable returns. 

Additionally, the ESG index’s higher Calmar ratio and lower maximum drawdown (-37.22 per cent versus -38.10 per cent) indicate better resilience in market downturns, even as the Nifty 100 leads in 12-month win percentage (91.67 per cent versus 81.25 per cent). 

The Nifty 100 Enhanced ESG index shows promise with slightly higher total returns, CAGR and improved drawdown resilience compared to the Nifty 100, making it a compelling choice for investors prioritising ESG factors without sacrificing long-term growth. However, the Nifty 100 index exhibits stronger annualised returns, lower volatility and a higher 12-month win rate, making it potentially more appealing to conservative investors seeking consistency and lower risk. 

Performance of Individual ESGDedicated Funds
The performance of ESG funds in India, as highlighted in the table (Performance Analysis of Prominent ESG Funds), is not consistent across different asset management companies. Quant ESG stands out with an impressive total return of 174.37 per cent from March 2021 to October 2024, far surpassing the other funds in this category. Its compound annual growth rate (CAGR) of 32.25 per cent and Calmar ratio of 1.74 indicate a high level of return generation relative to its risk, with a relatively low maximum drawdown of -18.49 per cent. Additionally, Quant ESG achieved a remarkable 100 per cent win rate over a 12-month period, demonstrating consistent performance in recent times. One of the reasons it achieved such return was due to higher churn ratio. The fund keeps booking profit on a regular basis and invests in new companies. 

Among the other ESG funds, ICICI Prudential ESG and Invesco India ESG also show strong performance, with total returns of 98.04 per cent and 89.89 per cent, respectively, and respectable CAGR values of 20.83 per cent and 19.43 per cent. Both funds maintain good risk-adjusted metrics, with ICICI Prudential ESG having a higher Calmar ratio of 1.09 and Invesco India ESG a Calmar ratio of 0.85, indicating better resilience during market downturns compared to Axis, Kotak and SBI ESG. 

These funds also have high win rates over 12 months, with ICICI Prudential ESG at 81.82 per cent and Invesco India ESG at 69.7 per cent. In contrast, Axis ESG and Kotak ESG have lower total returns of 64.26 per cent and 71.46 per cent, and correspondingly lower CAGRs and risk-adjusted returns, reflecting a more conservative approach compared to their peers. Overall, the data reveals that while Quant ESG has outperformed with exceptional returns, other funds like ICICI Prudential ESG too offered solid growth potential, with moderate risk-adjusted returns and reasonable volatility. 

Portfolio Constituents
The sectoral composition of ESG funds indicates a strong preference for sectors with high governance standards, digital transformation and environmental sustainability. The largest allocation to lending and IT, which constitutes almost 43 per cent of the AUM shows the lopsided nature of the portfolio. These funds are going to perform only if these sectors will do well. 

Reasons for Investing in ESG Funds
In conclusion, selecting the right ESG fund requires balancing your financial objectives with your personal values. Investors looking to make a meaningful impact through their portfolios should seek funds with a transparent ESG strategy, a credible approach to sustainable investing and alignment with their values. The recent SEBI guidelines have strengthened ESG criteria, providing six strategies—exclusion, inclusion, best in class, impact investing, sustainable objectives and transition investments—that enable investors to choose funds that suit their ethical preferences. 

Furthermore, with SEBI’s requirement for 80 per cent equity allocation and 65 per cent investment in companies with robust business responsibility and sustainability reporting (BRSR), ESG funds in India now adhere to stricter standards, promoting a more impactful and authentic investment approach. For those new to ESG, a strategic allocation of 5-10 per cent of a portfolio to these funds can be an effective way to support sustainable practices without sacrificing returns. 

Funds like those offered by ICICI and Quant have shown potential in balancing ESG considerations with financial performance. While ESG funds may not yet match traditional funds in terms of returns, they offer a unique value by channelling capital into companies that prioritise ethical and sustainable growth. As ESG investing gains traction, it provides investors with an opportunity not only to pursue financial growth but also to support businesses that contribute positively to society and the environment. 

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