What Are ESG Funds & Should You Invest in Them?

Investors are getting more concerned about how well companies can operate beyond monetary rewards. Factors like environmental responsibility, ethical treatment of stakeholders, and corporate governance are becoming equally important. ESG funds also identify with this change of direction. Wondering “what is ESG invest?” These are funds that target companies that are in line with particular environmental, social, and governance criteria.

What Does ESG Stand For?

ESG stand for the three core pillars used to assess a company’s sustainability and ethical practices:

• Environmental (E): Helps to gauge the impact of an organisation on the planet. These include analysing the overall carbon footprint, use of water, energy efficiency, management of waste and the prevention of climate change.
• Social (S): It evaluates the manner in which an organisation treats employees, customers and society. The major aspects are diversity and inclusion, employee rights, product safety, data privacy and community engagement. It also looks at the overall impact a certain company can have on its community.
• Governance (G): Focuses on ethical leadership, board Diversity, Equity and Inclusion (DEI), executive pay, fairness, pay parity, shareholder rights, transparent policies, and strict regulatory compliance.

What is an ESG Mutual Fund?

An ESG mutual fund invests in companies that meet defined environmental, social, and governance benchmarks. To classify a scheme as ESG, fund managers rely on third-party ESG rating providers, internal research and disclosures from companies. ESG scores are published by agencies like MSCI, Sustainalytics or Refinitiv and often guide these decisions.

In India, SEBI has issued specific guidelines:

• Only equity schemes can be labelled ESG funds.
• Schemes must clearly disclose their ESG strategy (exclusion, integration, best-in-class, impact investing, etc.).
• Asset Management Companies (AMCs) must invest at least 80% of assets in ESG-compliant securities.
• Fund houses are required to disclose the ESG rating provider and scoring methodology.

Global benchmarks such as the MSCI ESG Leaders Index are also used to track top-performing companies with robust ESG practices.

Types of ESG Funds

There are different types of ESG funds, each defined by its investment approach and selection criteria: 

• Exclusionary or Negative Screening Funds: Avoid investing in industries considered harmful or controversial, such as tobacco, alcohol, gambling, weapons, or fossil fuels. This approach is also known as Socially Responsible Investing (SRI).
• Positive Screening Funds: Invest in companies with the highest ESG ratings within their sector or region.
• Best-in-Class Funds: Select top ESG performers even in industries with higher environmental or social impact, such as the most sustainable oil company.
• Thematic ESG Funds: Focus on specific ESG-related themes like clean energy, water conservation, green technology, or gender equality.
• Impact Investing Funds: Invest in projects or companies that create measurable positive outcomes for society or the environment, such as affordable housing or clean water initiatives, while also aiming for financial returns.

Green Bonds

Green bonds are fixed-income securities issued to finance eco-friendly projects such as renewable energy, sustainable agriculture, clean transportation, and pollution control. They attract investors seeking stable returns while contributing to climate goals, making them a popular tool in sustainable and responsible investing.

Climate Funds

Climate funds channel money into companies and projects that combat climate change. These include renewable energy, carbon reduction technologies, sustainable infrastructure, and climate-resilient businesses. For investors, climate funds offer exposure to growth sectors while supporting the global transition to a low-carbon economy.

Key Differences Between ESG Funds and Traditional Funds

The key differences between ESG funds and traditional funds can be understood through the following comparison:

Aspect	ESG Funds	Traditional Funds
Investment Criteria	Focus on companies with strong Environmental, Social, and Governance (ESG) practices in addition to profitability.	Focus on profitability, past performance, and growth potential.
Risk Management	Integrate ESG practices to assess and mitigate risks impacting long-term business performance.	Use conventional financial and market analysis methods to manage risk.
Financial Performance	May prioritise sustainability and long-term stability over short-term gains.	Aim to maximise short-term and long-term financial returns for investors.
Societal Impact	Designed to create a positive environmental and social impact through investments.	Societal impact varies depending on the companies selected in the portfolio.

Should You Invest in ESG Funds?

Like any investment, ESG funds have their pros and cons. Here’s a balanced overview of pros and cons so that you can get to know them better:

Pros:

• Alignment with ethical values: Enables investment in companies that uphold causes such as climate action, human rights, and corporate ethics.
  
• Long-term stability: ESG-driven businesses are better positioned to avoid legal, financial, and reputational risks, supporting consistent performance over time.
  
• Growing market appeal: With ESG assets projected to exceed $50 trillion in the coming years, sustainable investing is attracting a rapidly increasing investor base.

Cons:

• Reduced diversification: Excluding certain industries can limit the range of investment opportunities.
  
• Inconsistent ESG ratings: Variations in scoring methodologies may result in differing evaluations of the same company.
  
• Variable performance: ESG funds may underperform at times due to a narrower stock universe or sector-specific exposure.

The Future of ESG Investing in India

India is witnessing the rapid adoption of ESG investing, supported by SEBI’s BRSR (Business Responsibility and Sustainability Reporting) aimed at enhancing transparency among companies and mutual funds. Growing awareness, particularly among younger demographics such as Gen Z and Millennials, is driving demand for sustainable investment products. As a result, ESG mutual funds are evolving into mainstream investment options with strong growth potential rather than remaining a niche segment.

*Disclaimer: This blog is for educational purposes only and does not constitute financial advice. Please consult a registered financial advisor before making any investment decisions.

FAQs

Are ESG Funds a Good Investment?

For long-term growth, ESG funds can be a strong investment choice, especially for aligning capital with specific ethical values. However, they are not immune to market risks. As with any mutual fund, returns depend on market conditions, fund strategy, and portfolio composition. Clear assessment of investment objectives, both in terms of risk tolerance and return expectations, is essential before selecting an ESG fund.

What Do ESG Funds Invest In?

ESG funds, regulated by SEBI and guided by global frameworks, invest in companies meeting environmental, social, and governance  standards. These include clean energy providers, ethical businesses, or tech firms with strong data privacy, while excluding industries like fossil fuels, tobacco, gambling, and weapons.

Is ESG investing tax-efficient in India?

Yes, ESG funds are taxed like equity mutual funds. STCG (within 1 year) is taxed at 15%, while LTCG (after 1 year, above ₹1.25 lakh exemption) is taxed at 10%. This makes ESG funds tax-efficient compared to many debt-oriented options. 

How do ESG funds perform compared to Nifty 50/Sensex?

Performance varies, but ESG funds often show resilience in market downturns due to quality-focused investing. However, they may underperform in rallies driven by excluded sectors like oil, tobacco, or defense. Several ESG funds also benchmark themselves against indices like the Nifty 100 ESG, which track companies meeting defined sustainability and governance standards

Are ESG funds good for SIP investors?

Yes. ESG funds suit SIP investors looking for long-term wealth creation with sustainable businesses. However, returns may fluctuate as the ESG theme is relatively new in India.