ESG mutual funds have been long sought after by investors across Europe and North America, in most developed countries and economies.
In India
they have gained attention from investors and momentum from Mutual fund
companies in the form of new launches only in the past few years though.
ESG mutual
funds invest in stocks from the same universe that other equity mutual funds
invest in.
The
difference lies in the reason for picking and not picking a particular stock.
ESG mutual funds are more concerned with how
money is made rather than how much money is made, they are more concerned with
a how a business makes profits rather than how profitable the business is.
A ESG mutual fund is not your traditional
mutual fund scheme, it views companies from the ESG lens and therefore the
parameters and filters for it are not the same as other mutual fund schemes.
ESG mutual funds are built and run on the
following three pillars:
Environment
The fund reviews and judges a company based on:
- Its carbon emissions if any
- Its positive contribution to climate change
- How efficiently it uses the natural resources
- Water and waste management.
The fund does not expect chemical or refinery
businesses to all of a sudden stop using water but it does expect such
businesses to use water more efficiently and only release effluents into a
natural body of water after it has been treated well.
Social
The fund reviews and judges a company based on:
- Labour management
- How it treats its customers
- Diversity at the workplace
- Gender diversity
- Its positive involvement and contribution to society at large
- The stand in takes on social issues
The stand the company takes on socially
relevant issues has a big say in whether customers want to see themselves aligned
or associated with the company.
Governance
The fund reviews and judges a company based on:
- It’s Whistleblower policy
- Bribery and corruption policy
- Diversity and composition of its board
Any irregularities
with the numbers reported, financial fraud does not show the company in good
light. This not only affects the share price of a company but also puts all the
stakeholders in a position where they are compelled to review their decision to
be associated with a company they feel they cannot trust.
ESG Mutual Funds Investing strategy
ESG mutual funds are
more concerned with what companies get right rather than what they get wrong.
The idea is to pick
companies that meet certain standards that have a positive impact on the
environment in every aspect and thereby a healthy outlook for the company too.
If a company has
been fined by the environmental authorities for releasing unfiltered effluents
into the waters then it would affect the stock price negatively too.
Other examples would include unfair working conditions and any corruption or bribery charges levied against
it.
All these events
affect everyone related to the company including the shareholders and overall
the environment in every aspect.
ESG mutual funds try
to avoid these companies and therefore there is better downside protection
which is as important as upward movement in share prices.
Features
of ESG mutual funds
ESG mutual funds are as concerned with the ethical side of business
as they are with the financial side.
They do not prioritise one over the other.
ESG mutual funds go and look beyond the numbers for
statistics have an uncanny ability to conceal what needs to be revealed.
These funds though not a new idea globally are all about
accountability, from everyone and not just one or a group of people because the
environment affects us all.
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Need
for ESG mutual funds
Coronavirus has given the entire world more than enough to
take note of why how doing business is as important as how much business is
done and profits made.
Climate change is real and it’s only going to get worse
until and unless each and every individual is on the same page.
Every year we read about a flood crisis in some part of the
country or the other.
Air pollution has been an issue in most major cities of our country.
The younger generation is not only worried about its own future
but that of the coming generations too and therefore demands accountability
from how the companies they invest in make money.
Advantages of ESG mutual funds
ESG mutual funds
tend to be less volatile than other mutual funds since they refrain from
investing in companies, they believe are not transparent or run the risk of
financial malpractices among other things.
The strong filtering
process makes sure the fund only invests in sustainable businesses that provide
long term growth while complying with all the necessary standards.
They are more
favourable to investors that look for overall growth and not merely on the
financial side.
Disadvantages of ESG mutual funds
Because of the
stringent filtering process, the fund has a limited universe from where it can
pick which companies to invest in and which to avoid.
This makes for a
very focused portfolio and thereby the fund does not get the privilege of as
much diversification as say other equity mutual funds.
ESG mutual funds
cannot be the core portion of your mutual fund portfolio since at the end of
the day they are still thematic mutual funds.
These funds may not
always work in a bull market since they may have to overlook certain companies
and sectors that do not meet the ESG requirements.
India as an economy is still dependent for foreign
investment and since ESG is not a novel idea abroad, foreign investors would in
time as the idea picks pace in India also look for companies that adhere to the
ESG standards.
This is a win win situation for both the economy specifically
and the overall environment generally.
Companies would be encouraged to run their businesses in a
more environment friendly manner that would be beneficial to both the current
generation as well as the forthcoming generations.
Our environment is deteriorating every day and therefore
sustainability no more remains a fancy word or a battle only a few can pick and
even investors around the globe no more shy away from the need to hold
themselves accountable.
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