When we think about investing, we usually focus on things like returns, company performance, valuation, past track records, or the reputation of the asset management company. But today, as we witness the growing environmental degradation and climate change, there’s a shift in the mindset of many investors.
More and more individuals are beginning to care just as much about how a company operates as they do about how much it earns, by assessing how companies treat the environment, their employees, and society in general.
That’s why investors are considering investing in green funds, or as they are more commonly known here, ESG funds, as part of their financial planning. These funds are considered a kind of green investment as they focus on companies that act responsibly and follow sustainable business practices.
What Is a Green Fund?
When we talk about green funds, we’re talking about mutual funds that invest primarily in shares of companies that practise environmentally sustainable, socially responsible, and ethically governed business models, such as those involved in renewable energy, electric cars, clean tech, waste management, or companies with strong ESG (Environmental, Social, Governance) ratings.
The term is not commonly used in India, as here such funds are referred to as ESG funds.When fund managers select the stocks to invest in, they assess how companies handle:
- The environmental impact of their operations: This includes evaluating factors like their carbon emissions, waste management systems, water conservation, pollution control, and energy efficiency. The higher the company scores in these aspects, the more ‘green’ they are considered. For example, a company manufacturing solar cells and wind turbines would score highly on environmental criteria as they help generate renewable energy. Similarly, a business focusing on electric cars will also be looked at favourably by fund managers.
- Their social responsibility: Fund managers score companies on the basis of how they treat their employees, support community welfare, and promote education and healthcare. Other factors like gender equality, labour rights, fair wages, and safe working environments are also closely considered.
- Governance standards: This part involves analysing the qualitative aspects of a company, like its leadership structure, how compliant it is with regulations, its transparency in financial reporting, ethical conduct, and how well it protects its shareholders.
How Do Green Funds Work?
Green funds work the same way as any other mutual fund. They are a pooled investment where a professional fund manager invests the corpus in a diversified basket of securities. What sets green funds apart is the way in which this portfolio is selected. Instead of just looking at financial metrics, managers assess companies on the basis of ESG scores.
While there is no set standard for ESG scoring, the general idea is to prioritise companies that align with the many ESG parameters. For individuals, investing in these funds also works the same as other mutual funds. You can buy units with a lump sum or through an sip investment plan if you want to take the regular contribution approach.
Purpose and Objectives of Green Fund
The main goal of a green fund investment is to deliver strong returns by investing in companies that score well on ESG parameters. Since these equity-oriented funds are actively managed, managers aim to outperform benchmarks like the Nifty 100 ESG Index. These are long-term vehicles which not only offer environmentally-conscious individuals the opportunity to invest in a diversified portfolio but are also well-positioned to benefit from the growing awareness around environmental sustainability and ethical business practices.
As more people and companies recognise the importance of environmental protection and honest governance, businesses that align with ESG principles will likely gain a competitive edge.
Since equity means ownership, the more socially aware investors these days try to prioritise and support companies that align with their values. If you too want to create long-term wealth but wish to do so by investing in ESG-responsible companies, consider consulting with a mutual fund investment planner first. They can help you identify the right green investment that matches your financial goals and values.
Types of Green Funds
The main type of green investment funds available in India today are the ESG funds. These funds gained significant popularity during the COVID-19 pandemic, so they are still an emerging category. Other than these, several thematic funds focus on specific sustainability-related sectors, like renewable energy and natural resources.
Thematic funds are considered very risky due to their sector concentration. As the name suggests, they focus on a narrow theme, which means their performance is highly dependent on the success of that particular industry. For example, a renewable energy fund can sometimes see peaks but can also face steep declines if the sector underperforms. A financial planner can assess your risk tolerance to help you understand whether or not such funds align with your financial goals and investment horizon.
Key Components of Green Funds
Fund managers assess companies based on their ESG scores to ensure they are making a genuine green investment. This ESG assessment forms the core of the fund’s selection process and helps align the portfolio with the values of its socially and environmentally conscious investors. Components include:
Environmental Responsibility
- Funds evaluate how companies treat the environment by looking at factors such as:
- How companies use and conserve water
- Their efforts to control pollution
- Waste management practices
- Company’s impact on climate
- Carbon emissions
- Their use of renewable resources
- Whether the company makes energy-efficient choices
Social Impact
- This refers to how a company treats its employees and how responsible they are towards society as a whole. Includes factors like:
- Gender diversity and equal pay
- Labour rights
- Employees welfare
- Contributions towards public healthcare and education
- Impact of business on the local communities
Governance Practices
Fund managers evaluate the following factors to ensure the company they’re investing in has ethical governance:
- Board structure and compensation
- Transparency in disclosing profits and income statements
- How they treat their shareholders
- History of corruption in the organisation
- A company’s political contributions
ESG Ratings
Funds assess ESG scores made by independent agencies to ensure the companies they select score well on ESG compliance. As stated previously, there is no clear definition of ESG, so different agencies, like Morningstar, MSCI, and Sustainalytics have different ESG scoring criteria. A qualified investment planner can help you understand how these components work together to form a green portfolio.
Benefits of Green Funds
By investing in green funds one can reap many benefits:
- Diversification and professional management: A green fund invests in an expertly selected basket of stocks to lower risk. Some green funds, like thematic funds revolving around green energy, can be very risky as their diversification is only spread across a handful of industries.
- Long-term investment: Most green funds are equity-oriented and thus perform better over the long term. Also, ESG companies keep up with sustainability trends, so they are expected to grow as awareness around ESG factors increases. For example, an electric car company can potentially benefit greatly as governments push for cleaner transportation and consumers shift towards eco-friendly vehicles. That’s why a retirement planner might recommend green funds to clients with a long investment horizon.
- Moral satisfaction: By investing in a green fund, you are investing in companies that align with your personal values. Just knowing that your money is invested in forward-thinking and sustainable companies can bring satisfaction along with returns.
- SIP option: Like other mutual funds, green funds allow you to make fixed and regular contributions through SIPs. This option offers many advantages like building financial discipline, affordability, convenience and flexibility, and rupee cost averaging.
- Tax benefits: Equity-oriented funds are more favourably taxed compared to debt-oriented funds. A tax consultant can help you understand the capital gains tax implications of your investments and advise you on how you can keep more of your hard-earned money through personalised strategies.
Challenges and Barriers to Green Funds
Now that we’ve discussed the advantages, it’s only fair to understand the challenges green funds face:
- Limited universe: One of the main challenges is the relatively small pool of companies that meet ESG standards, which limits the number of stocks fund managers can choose from when building a diversified portfolio.
- Lack of definition: What a green or ESG fund is, is not clearly defined by regulatory bodies. ESG scores also vary across independent agencies which makes it hard for funds to find companies that are ESG-compliant. Some ESG funds also invest heavily in companies that make substantial profits from tobacco, cigarettes, and fossil fuels.
- Inadequate historical data: ESG funds are relatively new in India, so the availability of long-term performance data is limited. This lack of information makes it hard for investors to assess consistency and whether these funds are capable of providing better risk-adjusted returns in the future.
- Higher risk: Since most green funds are equity-oriented and generally concentrated in select sectors like clean energy, banking, or technology, they carry higher risk.
- Greenwashing: When companies exaggerate or even falsely claim their practices are sustainable and environment-friendly, they are said to be engaging in greenwashing. Some companies use manipulative marketing or selective reporting to come across as more responsible than they actually are, which is a problem for funds and investors alike.
Creating and Managing a Green Fund
If you’re looking to make a green fund investment, ESG funds are your best option at the moment, followed by high-risk green energy thematic funds. While the number of such funds is still limited, rising awareness around sustainability can maybe drive both demand and long-term value in the future.
Before you invest, consider several factors such as the fund manager’s track record, fund history, the asset management company’s reputation, the fund’s AUM, risk-adjusted returns, alpha, and beta.
You should also review the fund’s holdings to make sure its investments truly reflect your values and that the fund isn’t investing in companies that are greenwashing. As always, make sure the fund’s philosophy matches your own, and that your investment aligns with your goals and tolerance for risk.
Conclusion
ESG and green investment funds are a relatively new category of funds in India. They are designed to combine financial growth with environmentally sustainable and ethical business practices. Every day, more and more investors become conscious of the impact their money can make, so these funds give them a viable route to align their personal values with long-term wealth creation.
While these funds face many challenges, increasing regulatory focus and growing awareness around issues such as climate change can help strengthen them in the future. Several factors should be assessed before investing in mutual funds. Get personalized investing advice by giving our experts a call today!
