In many countries around the world, funds that invest in companies that perform well on the environmental, social and governance (ESG) standards are quite popular. This is a relatively new concept in India, and most ESG funds have only been introduced in the past two to three years. Until now, such funds were categorised as thematic equity funds, but SEBI has approved a new category in its board meeting on March 29, to be called the ESG Category. ESG funds will now be placed under this category. In thematic funds, 80 percent of investments are made in shares of one theme. Asset allocation of ESG funds is mainly based on bonds and shares selected on the basis of environmental, social welfare, and corporate governance. The selection of shares in them is based on strong ESG research. Fund managers invest in companies that are performing well financially and whose positive impact on society can also be seen.
So, how does one determine if a company is performing better on the ESG standard. SEBI has announced the beginning of the Business Responsibility and Sustainability Reporting (BRSR) core. The core will have several key performance indicators (KPIs) that listed companies must achieve a valid score. SEBI has mandated the disclosure of ESG based on this report for the top 1000 companies. Such companies will need to include Business Responsibility and Sustainability (BRSR) reports in their annual reports. SEBI has said that ESG funds must invest at least 65% of their assets under management in companies that have been assured BRSR Core assurance. As per the rules, companies that do not provide BRSR reports from October 2023 will not be able to receive ESG fund investments.
What kind of investors prefer investing in such funds or companies? Should you invest money in such funds?
Many investors trust that ESG-focused companies have better growth potential, which means their investors can also make good money. These companies also demonstrate better resilience during downturns.
ESG funds carefully evaluate companies and make investment decisions in shares of ESG-compliant companies. This means that ESG fund managers do not invest in companies engaged in socially and environmentally harmful businesses, such as tobacco, alcohol, gambling, or companies with low governance standards.
Choice of companies
Now the question is on what basis fund managers choose companies? After selecting companies that comply with ESG standards, fund managers usually make investment decisions based on fundamental analysis. For this, a company’s business, management, and valuation are taken into account. The emphasis is on the company’s ability to provide long-term profits, the quality of its corporate governance, and whether its valuation is appropriate or not.
Fund managers believe that ESG issues have an impact on the risk and return of investments. Therefore, they closely monitor companies that they can invest in actively with a deep focus on such issues. However, the parameters for selecting shares of different fund houses may vary.