If you want to invest in the high-performing mutual funds, while being true to your moral compass at the same time —  you can explore a category known as ESG, or environmental, social and governance. Although ESG funds have been around for a while, the good news is that their scope has widened in the recent past.  

Earlier each mutual fund house was permitted to launch only one scheme under the ESG category. The capital markets regulator Sebi, in a circular issued in July last year, gave a green signal to multiple ESG schemes, so long as they are launched with different investing strategies.

Let us first understand what ESG schemes are!

What are ESG funds?

These are thematic mutual funds which invest in those entities which have demonstrable commitment to environment, social causes and governance, thus living up to the cause of ESG.

These funds are not meant to invest in the companies which are low on ESG, even if they are delivering high returns to their shareholders. For example, a company that makes cigarettes or which has been accused of a large financial fraud in the past cannot make it to an ESG fund’s portfolio.

Multiple ESG schemes

Earlier, mutual funds were permitted to launch only one ESG scheme under the thematic category of equity scheme. As per the Sebi master circular dated May 19, 2023 on mutual funds, it was decided to introduce a separate sub-category for ESG investments under the thematic category of equity schemes.

The circular had clarified that any scheme under the ESG category will be launched with one of the following strategies:

A. Exclusion: This strategy excludes securities based on certain ESG related activities, business practices, or business segments

B. Integration: This strategy explicitly considers ESG related factors that are material to the risk and return of the investment, alongside traditional financial factors, when making investment decisions.

C. Best-in class and positive screening: This strategy aims to invest in companies and issuers that perform better than peers on one or more performance metrics related to ESG matters.

D. Impact Investing: This strategy seeks to generate a positive, measurable social or environmental impact alongside a financial return and how the fund manager intends to achieve the impact objective. The fund should seek a non-financial (real world) impact and evaluate if that impact is being measured and monitored.

E. Sustainable objectives: This strategy aims to invest in sectors, industries, or companies that are expected to benefit from long-term macro or structural ESG-related trends.

F. Transition or transition related investments: This strategy aims to invest in companies and issuers that support/facilitate environmental transition and just transition. The investment should generate a positive and measurable social and environmental transition.

It is vital to note that the mutual fund schemes are meant to mention the strategy in the name of the fund. For instance, ABC ESG Exclusionary Strategy Fund, XYZ ESG Best-in-class Strategy Fund, etc.

Additionally, minimum 80 percent of the total assets under management (AUM) of ESG schemes will be invested in equity and equity related instruments of that particular strategy of the scheme while the remaining portion of the investment will not be in contrast to the scheme’s strategy. 

Some broad rules

1. At present, the ESG schemes of mutual funds are mandated to invest only in such companies which have comprehensive business responsibility and sustainability reporting (BRSR) disclosures.

2. The new rules, however, mandate that an ESG scheme will invest at least 65 per cent of its AUM in companies which are reporting on comprehensive BRSR and are also providing assurance on BRSR Core disclosures. The balance AUM of the scheme can be invested in companies having BRSR disclosures.

3. The new requirement will be applicable with effect from Oct 1, 2024.