ESG Funds can reward investors, create wealth: Chirag Mehta of Quantum Mutual Fund

Equity as an asset class plays an important role in one’s portfolio. Over the last few years, supported by the reform measures taken by the government (even in times of the COVID-19 pandemic), Indian equities have been on a dream run. The Indian equity markets are at a lifetime high and the potential to rise further exists given that the Indian economy is a bright spot. Over the last two decades, the S&P BSE Sensex -TRI, has generated a CAGR of around 17.2% (as of June 30, 2023), and the midcaps and smallcaps have generated even better returns. If one maintains an optimal allocation to equities, building respectable wealth, beating inflation, and accomplishing financial goals are possible. And what better way, if one can achieve their goals while doing good for the planet than with ESG investing.

ESG Investing

Over the last couple of years, thankfully, there is growing awareness towards conserving the environment and making the world a better place for generations. The disruptions brought by the pandemic, war, climate change, and pollution, are perhaps making us more thoughtful. Responsible investors are making ‘sustainable investments’, turning sensitive to the environment and paying heed to governance (G) so that it makes a positive impact on society at large. They are increasingly becoming aware of the significance of weighing investments beyond financial parameters and seek the presence of certain values or ethics that they identify with. The AUM of ESG Fund is likely to grow
In July 2019, when some fund houses began to offer ESG as an investment theme in India, the total AUM of all ESG funds was about Rs 2,332 crore. Today, as of May 2023, the ESG Funds AUM in India is Rs 10,350 crore. While this number is lower compared to ESG AUM of Europe and the US, it is likely to increase with the awareness and interest of investors for sustainable and responsible investing. As per Bloomberg Intelligence, ESG AUM could grow to USD 53 trillion by 2025, more than a third of the global AUM.

In the current times, with the focus on reducing carbon emissions, green energy, EVs, a chemical-free environment, batteries, digitization, and so on, ESG investing is likely to gather more steam. The Union Budget announcements of the last couple of years have laid enough emphasis on sustainability with a green credit programme, the use of alternative fertilisers (to balance the use of chemical ones and promote natural farming), waste management, solar energy, and so on — all intended at nurturing ‘green growth’. The government is moving in line with its vision LiFE (Lifestyle for Environment) aimed at achieving its ultimate target of net zero carbon emissions by 2070.

Choose carefully
It is important that the ESG Fund is true to its label. The investment process and system must be in line with the ESG investment framework.

ESG investing still warrants an ESG lens–– one cannot solely rely on BRSR. At times, it becomes pivotal to move beyond desk research and go on the ground to conduct industry checks.

Studies show that when businesses follow good ESG practices, usually they are likely to attract customers and have a competitive edge. This results in them generating decent risk-adjusted returns arising out of a lower cost of capital and improved operational efficiency and thus better profitability. Also, during economic downturns, ESG-complying companies usually tend to show better resilience.

Benchmarking the Performance
The Nifty 100 ESG Index — designed to reflect the performance of companies within the Nifty 100 index based on Environmental, Social and Governance (ESG) risk score and used as the benchmark index for ESG Funds in India — has generated a 13.7% CAGR in the last 5 years (as of June 30, 2023). The index consists of stocks of companies that could add value through sustainable business models.

How have ESG Funds fared?
So far, the ESG Funds category in India, on average, has generated an absolute return of 21.1% in the last 1 year and 8.3% CAGR over 2 years, outperforming the Nifty 100 ESG Index. Three ESG funds that have completed a 3-year performance track record have clocked a CAGR of 21.1% on average, wherein some have even been able to fare better than the Nifty 100 ESG Index, i.e., generate alpha (as of June 30, 2023).

Adjusting for risk (over 3 years), most ESG Funds, according to the data sourced from ACE MF, have delivered respectable risk-adjusted returns (with an average Sharpe Ratio of 0.31 as of June 30, 2023).

But keep in mind that ESG does not automatically safeguard from the systemic risks associated with markets.

Who should consider ESG Funds?
It is necessary for investors to keep a relatively high-risk appetite and longer investment horizon when investing in ESG Funds.

Like beauty and value, ESG lies in the eye of the beholder. ESG Funds can reward investors well and are a sensible way to wealth creation over the long run.

The five key benefits of ESG investing are:

1. Offers a solution for socially responsible investing.
2. Fair diversification with, of course, Environment, Social, and Governance aspects being the focal points in the investment process.
3. Offers an avenue for better investment allocation.
4. The risk is possibly mitigated with robust investment processes in place.
5. The potential to deliver long-term risk-adjusted performance as compared to its benchmark.

Nonetheless, investors should speak to their SEBI-registered investor adviser before adding an ESG Fund to their portfolio.

(Chirag Mehta is CIO of Quantum AMC)