ESG funds — sustainability investing in India

ESG investing — incorporating Environmental, Social, and Governance factors into equity selection — has grown substantially globally since 2015. Indian mutual fund ESG products emerged around 2018-2020 and remain a small fraction of total equity AUM. The methodology around what counts as "ESG-eligible" remains contested, and concerns about "greenwashing" — funds claiming ESG credentials with weak actual implementation — persist.

The three pillars

Environmental

Climate change, emissions, energy consumption, water usage, pollution, biodiversity. ESG funds may exclude companies with high carbon intensity, or favor those with strong renewable energy commitments.

Social

Worker rights, community impact, customer protection, diversity and inclusion. May exclude companies with poor labor practices or tobacco / gambling exposure.

Governance

Board composition, executive compensation, audit quality, related-party transactions, disclosure practices. Strong corporate governance is the most directly performance-correlated factor in the ESG triad.

SEBI's framework

In 2021, SEBI introduced "Business Responsibility and Sustainability Report" (BRSR) requirements for the top 1000 listed companies — providing ESG-relevant data for mutual fund and broader investor use.

In 2023, SEBI categorized ESG schemes under a sub-category of "Thematic" funds, with disclosure requirements:

• Schemes must clearly articulate the ESG strategy used.
• Required to maintain at least 80% of portfolio in stocks complying with the stated ESG strategy.
• Must follow a "do not divest if any company falls below threshold" rule for engagement-based approaches.
• Annual disclosures on stewardship activities, voting records, and engagement outcomes.

ESG approaches

Negative screening

Exclude companies in specific sectors (tobacco, gambling, weapons, fossil fuels, alcohol). Simplest approach but doesn't capture all ESG dimensions.

Positive screening / best-in-class

Within each sector, invest in the companies with the best ESG scores. Allows broad sector exposure while tilting toward better-managed firms.

Thematic ESG

Focus on specific themes — renewable energy, clean tech, gender-diverse boards, low-carbon transition.

Integration

Apply ESG considerations alongside traditional financial analysis without strict exclusions. Most common approach in mature ESG markets.

Engagement / stewardship

Hold companies including those with weak ESG records, but actively engage with management to drive improvement. Voting at AGMs is the most visible form.

Performance evidence

Globally, ESG funds have shown:

• Comparable returns to non-ESG peers over 5-10 year windows.
• Some periods of outperformance (during sustainability rallies) and underperformance (during energy / fossil-fuel rallies).
• Lower drawdowns in major crises (some evidence).
• Mixed evidence on whether the "G" (governance) drives most of the performance differential.

In Indian markets the track record is shorter and less conclusive.

The greenwashing risk

"Greenwashing" — overstating ESG credentials — is a persistent concern:

• Funds marketed as ESG that don't materially differ from broader indices.
• Exclusion lists that are narrow (e.g., excluding only the most obvious tobacco/gambling) while including companies with substantial environmental impact.
• Selection methodology that allows any company to qualify with minimal screening.
• Lack of independent verification of ESG claims.

SEBI's BRSR framework attempts to reduce greenwashing by requiring standardised disclosures, but the data quality and the application by funds remain works in progress.

How to evaluate ESG funds

• Specific ESG criteria used — vague "ESG factors considered" is weak; specific exclusions and inclusions are stronger.
• Tracking error vs Nifty 500 or similar broad index — material difference suggests genuine ESG tilt.
• Stewardship reports — does the AMC engage with companies on ESG issues? Vote on shareholder resolutions?
• Sector concentration — heavy concentration in IT services and pharma can indicate "low-carbon" screening that excludes large industrial sectors.
• Methodology transparency — is the scoring approach publicly disclosed?

Tax treatment

ESG equity funds qualify as equity-oriented if ≥ 65% domestic equity. Standard LTCG / STCG rules apply.

Sector composition in Indian ESG funds

Typical concentrations:

• IT services (low direct environmental impact).
• Pharmaceuticals (some exclusions for environmental impact).
• Consumer goods (governance-screened).
• Selected financial services (governance-focused).
• Some renewable energy exposure.

Typical exclusions:

• Tobacco, gambling, weapons companies.
• Some coal-heavy power utilities.
• Companies with serious governance flags.

What ESG investing won't do

• Solve climate change through individual investment choices alone.
• Guarantee better returns than non-ESG peers.
• Eliminate exposure to all socially controversial activities (no fund is perfectly clean).
• Replace direct activism, voting, or other forms of engagement on environmental and social issues.

What ESG investing can do

• Align portfolio with personal values.
• Modestly reward companies with better governance and risk management.
• Contribute to the gradual shift in capital allocation toward sustainability-oriented businesses.
• Reduce exposure to specific risks (regulatory action on polluters, social litigation on poor labour practices).

Position sizing

For most investors:

• 5-15% of equity allocation as a values-aligned tilt.
• Combine with diversified core for portfolio breadth.
• Don't expect outperformance; expect approximately market-aligned returns with ESG tilt.

The future

As BRSR data deepens, as SEBI tightens disclosure, and as institutional capital with explicit ESG mandates grows, the Indian ESG fund category is likely to expand and become more rigorous. The methodology questions will gradually resolve through industry practice and regulatory guidance.