Sebi allows mutual funds to expand ESG offerings: Should you invest?

Market regulator Securities and Exchange Board of India (Sebi) has allowed mutual funds to expand  basket of offerings in the environmental, social, and corporate governance category. he five new categories are -- exclusions, integration, best-in-class and positive screening, impact investing and sustainable objectives. It has also put in place a disclosure and compliance framework for these schemes. This assumes significance as currently mutual fund houses are allowed to launch only one ESG scheme under the thematic category of equity schemes. 

The regulator further clarified that minimum 80 per cent of the total assets under management (AUM) of ESG schemes will have to be invested in equity & equity related instruments of that particular strategy of the scheme. 

 

In terms of investment criteria, while currently the ESG schemes are allowed to invest only in such companies that have comprehensive Business Responsibility and Sustainability Reporting (BRSR) disclosures.  

The more information a company discloses, the higher its ESG score. This is because transparency plays an important role in good governance, and corporate behavior becomes more measurable.

ESG schemes have now been allowed to invest at least 65 per cent of its AUM in companies which are reporting on comprehensive BRSR and are also providing assurance on BRSR Core disclosures. The balance AUM of the scheme can be invested in companies having BRSR disclosures. This requirement will be applicable from October 1, 2024.

With regards to disclosure requirements for ESG schemes, Sebi said mutual funds will have to clearly disclose the name of the ESG strategy in the name of the concerned ESG fund.

What does this mean? 

ESG funds are thematic mutual funds which invest in those companies that have demonstrable commitment to environment, social causes and governance.

Fund houses will now have an opportunity to launch more such funds.

BRSR Core mandates 49 key parameters for ESG reporting, under which objective disclosures are made along the lines of environment, social causes and corporate governance. This enables an assessment of firms across sectors and industries.

ESG funds cannot invest in the companies that are low on ESG, even if they are delivering high returns to their shareholders.

What does it mean for investors? 

"It might be confusing for investors to choose from an already long list of funds. Our timeless advice is to avoid thematic and sectoral funds in general. If you're still keen on these funds, wait and watch before investing in any new schemes being launched," said Value Research. 

With the latest Sebi move, mutual funds will have to provide more disclosures in terms of security-wise BRSR core scores and the name of ESG rating providing agency along with ESG rating. There  is a clear requirement that each scheme should have a distinct investment strategy and asset allocation under various themes, such as Exclusion, Integration, Best-in-class & Positive Screening, Impact investing, Sustainable objectives, and Transition or transition-related investments.

"Although it may initially seem confusing for investors to have multiple schemes with different approaches, it provides the flexibility to align one's investments more precisely with their ESG beliefs. Just as multiple categories in equity mutual funds cater to clients with unique preferences, the availability of various ESG schemes offers investors the opportunity to express their specific environmental, social, and governance considerations confidently," said Akshat Garg, CFP, CFP, Senior Manager (Research) Choice Broking

Sebi's move opens doors for impactful retail investing

This initiative will encourage MFs and provide investors with responsible investment avenues," said Ashwini Kumar, Head - Market Data, Icra Analytics Ltd. The new guidelines mandate higher disclosure, compliance with independent assurance, ESG audits and fund manager commentary and case studies.

"Many investors hold views and beliefs about what principles their investee companies should follow. Even before the concept of ESG became prevalent, particular sections of the investors would avoid tobacco, liquor, defence and gaming companies. Some investors would want their religious beliefs to be respected while choosing investments and would even avoid finance companies that charge interest.As the awareness about climate change has increased, investors wish to direct their capital towards environment friendly companies and away from non-compliant sectors or companies. The proposed framework recognises these needs," said Bharat Phatak, Director, Scripbox.

SEBI's recent move allowing multiple equity schemes under the ESG thematic category opens doors for impactful retail investing. Fund houses now have the opportunity to launch schemes under six different categories, thereby allowing investment opportunities for various investors across the 'impact' investing spectrum. However, complexities demand added evaluation criteria. Building a robust ecosystem with comprehensive research and data tools focused on ESG metrics becomes essential. This equips investors to make informed decisions in alignment with their values, fostering responsible and sustainable growth in the financial realm.

While Sebi's move opens doors for impactful retail investing, complexities demand added evaluation criteria. Building a robust ecosystem with comprehensive research and data tools focused on ESG metrics becomes essential," said Prabhir Correa, Vice President, Head - Philanthropy and Impact Investing, Waterfield Advisors.

But are ESG funds worth investing in?

"ESG is an emerging theme in the Indian markets. Thematic funds invest in fewer stocks, offering limited diversification. So, by investing in ESG funds, an investor is taking a concentration risk. Such a risk is only viable when an investor fully understands the space," said Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth.

Themes like ESG also see their high and low cycles.  Another challenge for retail investors is to time the entry and exit into the fund.  "Between 2012-2021, only 9 out of 87 thematic funds outperformed the Nifty 100. Just 6 of these beat the index on a risk-adjusted basis.  Thus, retail investors should refrain from thematic funds such as ESG to keep their portfolios simple. Even if they are highly inclined to invest, the allocation should not exceed 10% of the total portfolio," said Kulkarni.

 ESG funds were a rage a few years ago globally but several investors were not able to exit the party at the right time.  For example,  Vanguard ESG US Stock ETF, which doubled  in 2020/2021 fell by almost 30% in 2022 and is still down 10% odd from the highs despite the US markets markets performing well. 

"Such thematic funds ideally are for more mature and agile investors who can get in and get out with the trend. For long term investors we don't recommend thematic or sectoral investments due to its susceptibility to short term trends," said Vivek Banka, Co-Founder, GoalTeller,  a leading Indian financial services company.

Existing EGS funds in India 

Some existing ESG mutual funds in India include  SBI Magnum Global Fund which invests in large-cap companies across the globe that follow good ESG practices,  Aditya Birla Sun Life Advantage Fund- this fund invests in mid and small-cap stocks of companies with strong ESG credentials,  Franklin Build India Fund: The fund invests in a diversified portfolio of Indian companies that are leaders in their respective business segments and have strong ESG credentials and  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.

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.

"While ESG-compliant companies attract FPI money also,  investors should not take big exposure in the thematic fund and should allocate  only a small  percentage of the fund as an asset allocation strategy," said Mukesh Kochar, National Head-Wealth, AUM Capital.