What are ESG Mutual Funds: Types, Benefits and How it Works

ESG Funds: An Overview

Environmental, social, and governance (ESG) funds are investments that consider environmental, social, and governance factors when making investment decisions. A company that invests in an ESG fund should have a positive environmental and social impact and be well-governed. The aim is to generate financial returns while also making a positive impact on society and the environment. 

Many ESG funds are available to invest in a wide variety of assets, including stocks, bonds, and real estate. ESG funds have grabbed a lot of attention in recent years as more investors seek to align their investments with their values. According to Morningstar data, Indian ESG funds have experienced outflows in 12 of the last 14 months. In contrast, in July, equity mutual fund inflows reached a record high of $22,583 crore ($3.04 billion).

India, the world's fifth largest economy, has 23 ESG funds, compared to over 500 in the United States and Britain, 182 in Japan, and 119 in China.

What are ESG Funds?

ESG equity funds are mutual funds that invest in companies with strong environmental, social, and governance (ESG) practices. ESG funds try to promote sustainable business practices and help companies do good things for society. Many ESG funds also screen out companies that do bad things for the environment or society, like making tobacco products or nuclear weapons.

Types of ESG Funds

ESG funds come in many different shapes and sizes. Some common types include:

1. Green funds invest in companies committed to environmental sustainability.

2. Social impact funds: These funds invest in companies with a positive social impact, such as those working to improve access to education or healthcare.

3. Ethical funds invest in companies that adhere to high ethical standards, such as avoiding child labor or environmental pollution.

4. Sustainable development goals (SDG) funds: These funds invest in companies working towards the United Nations' 17 Sustainable Development Goals, which include combating climate change and achieving gender equality.

What are the Benefits of ESG Funds? 

ESG funds offer many benefits. For one, they can help diversify your portfolio and protect against potential risks. Additionally, ESG funds tend to outperform their traditional counterparts over the long term.

ESG funds also offer several social and environmental benefits. Investing in companies that are market leaders in environmental, social, and governance practices can help support positive change in the world. Additionally, you can rest assured that your investment supports companies committed to sustainable and responsible business practices.

How do ESG Funds differ from Traditional Mutual Funds?

ESG mutual funds are different in a few key ways from traditional mutual funds. One thing they do is focus on investments that are good for the environment, society, and the way the country is run. Also, they often use different screens to choose investments and may have different weighting schemes.

Traditional mutual funds are usually run to make the most money without considering ESG factors. It means traditional mutual funds may invest in companies that are bad for the environment or society.

ESG mutual funds, on the other hand, try to make money while also doing good things for the world. It can mean putting money into companies that are the best at lowering their carbon footprints or have good practices for dealing with employees. Also, ESG mutual funds usually don't put money into companies that do controversial things, like make tobacco or weapons.

Best ESG Funds in India

1. SBI Magnum Global Fund: The fund invests in large-cap companies across the globe that follow good ESG practices.

2. Aditya Birla Sun Life Advantage Fund: The fund invests in mid and small-cap stocks of companies with strong ESG credentials.

3. Franklin Build India Fund: The fund aims to provide long-term capital growth by investing in a diversified portfolio of Indian companies that are leaders in their respective business segments and have strong ESG credentials.

4. ICICI Prudential Value Discovery Fund: The fund invests in a diversified basket of large-cap stocks of companies that are available at attractive valuations and have strong ESG fundamentals.

How to Choose the right ESG Fund?

Choosing the right ESG fund for you is all about finding a balance between your investment goals and your values.

Do your research to find an ESG fund that aligns with your financial goals and values.

When choosing an ESG fund, investors should consider the following factors:

1. The fund’s investment thesis.

2. Elements of the fund’s portfolio composition, including investment types and sector weightings.

3. Fund management fees and performance fee arrangements.

4. Environmental, social, and governance (ESG) factors that could impact returns or potential risks associated with a particular fund.

5. Availability of research on the fund’s performance and ESG features.

Advantages and Disadvantages of ESG Funds

ESG funds are investment vehicles that focus on environmental, social, and governance issues. While they offer potential benefits, there are also some risks to consider before investing.

Advantages of Investing in ESG Funds:

1. ESG funds can help investors align their values with their investments.

2. ESG funds can potentially provide superior risk-adjusted returns.

3. ESG funds can help investors diversify their portfolios and mitigate downside risk.

Disadvantages of Investing in ESG Funds:

1. The performance of ESG funds is highly dependent on the underlying companies and industries in which they invest.

2. Many ESG funds have high fees, which can eat into returns over time. 

3. It can be challenging to find truly "green" investments, as most companies have some level of exposure to environmental or social issues.

Risks Associated with Investing in ESG Mutual Funds

Several factors should be considered before investing in an ESG mutual fund. These funds can provide some wonderful advantages, but there are also some risks. Before buying an ESG mutual fund, consider the following points:

1. Lack of Diversification: Since ESG mutual funds frequently concentrate on a single form of investment, they might not be as diverse as other types of funds. This lack of diversity can increase portfolio volatility and total risk by increasing it.

2. Limited Investment Possibilities: When investing in an ESG mutual fund, you should also be aware that there may be fewer investment options available. It could make it harder for you to locate the ideal investments for your portfolio and might even result in missed chances.

3. Greater Fees: Lastly, you should be aware that ESG mutual fund fees are typically higher than those for other investment vehicles. These funds' specialized nature frequently results in greater operational costs. Compare fees before investing and decide whether the added expense is worthwhile.

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Conclusion

This type of investment is becoming more popular as more and more people look for ways to invest in companies that share values. Even though there are many ways to invest in ESG funds, the most important thing is to research and pick the right one.

This is not an investment advisory. The blog is for information purposes only. Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements, risk tolerance, goal, time frame, risk and reward balance, and the cost associated with the investment before choosing a fund, or designing a portfolio that suits your needs. The performance and returns of any investment portfolio can neither be predicted nor guaranteed.