Are ESG themed mutual funds worth investing in?

Published: April 13, 2023 at 6:00 am

A reader wants to know if investing in an ESG-themed mutual fund is worth it. So some numbers and some discussion. In general, all thematic funds are unnecessary. The same logic applies to ESG, which gives off a “saving the planet vibe”!

What is the Environmental, Social and Governance (ESG) investment theme? It involves choosing stocks of socially responsible, environment-friendly and ethical firms to achieve superior risk-adjusted returns. Environmental empathy (E) includes efficient waste disposal, cognisance of climate change, pollution, energy and water conservation, etc.

Social Responsibility (S) includes company management with gender equality, women empowerment, labour welfare & rights, contribution to social causes etc. Corporate Governance (G) refers to businesses with ethical practices, efficient management, absence of fraud, illegal action etc.

Generally, an ESG investor will not pick stocks involved in any (major) controversy, engaged in tobacco, alcohol, controversial weapons, gambling etc. The ICICI Prudential ESG Fund presentation refers to these as “sin companies”.

Besides the natural aesthetic appeal of investing in ethical businesses, the key idea behind the ESG theme is such companies are unlikely to be impacted by controversy and regulation associated with E, S or G factors making the business more sustainable. This conscience-clearing stance is also expected to beat the market (e.g. the Nifty) in the long run.

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Calling X or Y firms a “sin company” is purely arbitrary. If producing alcohol is a sin, then so is producing sugar which is just as much a toxin to the liver as alcohol. What about firms that produce dairy or create dairy-based products? The point is ESG is an arbitrary, debatable notion that might appeal to those who wish to clear their conscience chasing stock returns.

Three stocks in the top holdings of Quantum ESG fund – HDFC, HDFC Bank and Infosys – are also among the top stocks of Quantum Long Term Value Fund. So one could argue that I am doing my bit to save the planet by investing in a diversified equity fund.

An industry expert who wishes to be anonymous said, “ESG stock selection suffers from poor data quality, lack of standardization and regulations of reporting on data, subpar quantification of several qualitative variables, large scale data mining coupled with mis-selling based on people’s Greed (earn better returns) and Morality(while doing good deeds). Overall, this is yet another opportunity to rip off people with 2% fees. In short, ESG Investing is not a good idea, and please stay away from them. There are several other less financially risky ways to help the planet “.

With that out of the way(!), if you like to look at the past performance of the NIFTY100 ESG Index, see our review of ICICI Prudential ESG Fund. Let us look at the trailing return of available ESG funds with at least one year of history as of April 3rd 2023.

Trailing returns of ESG funds compared with NIFTY100 ESG - TRI and NIFTY 50 TRI
Trailing returns of ESG funds compared with NIFTY100 ESG – TRI and NIFTY 50 TRI. The five-year return of the SBI fund should also be marked in red. It is incorrectly marked in blue.

Evidently, that is a pretty awful performance. If these AMs were so keen on lending a hand to save our planet, they would have launched a low-cost ESG index fund. At least then, the poor performance of the Nifty100 ESG index compared to the Nifty 50 would be palatable. We, therefore, recommend avoiding ESG funds.

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