ESG Mutual Funds In India Are Having A Reality Check

After an initial spike, ESG mutual funds in India are having a moment of reckoning. 

The relatively new class of funds has witnessed an exodus of flows for a majority of the past 18 months and seen its assets under management decline.

Ten of India's 13 ESG fund schemes tracked by Morningstar were launched after 2020. Data till August 2022 shows over the past 12 months, total fund size of the category has fallen 7.6% to Rs 11,981 crore. That's a far cry from the 180% growth seen in FY21 when most of these funds launched.

The schemes too have seen outflows in 11 of the last 18 months. That's when the equity mutual funds have seen continued inflows since April 2021.

"Much of the growth in ESG mutual funds that came between 2019 and 2021 was because there were a lot of new fund offers," said Kavitha Krishnan, senior analyst, fund research at Morningstar. "That's when people throng to these funds as the perception is that asset value moves up after the launch." 

"Given the reduction in NFOs, the traction has not been so much this year," Krishan said.

The problem is multifold.

Cart Before The Horse 

Supply for ESG funds in India came well before the demand even existed. 

By comparison, globally, the discussion around ESG was pushed forth by institutional investors like pension and sovereign funds," said Ashwin Patni, head of products & alternatives, Axis Asset Management, which launched an ESG scheme.

In India, it was the other way around. Investors. It wasn't really that the investor was coming and asking for an ESG product, he said. "It was more from the side of the fund managers that were establishing the importance of the ESG theme."

Yet, low appetite due to lack of awareness is just one aspect. For most of retail investors, returns are a bigger concern. 

ESG Funds And Returns 

ESG mutual funds simply don't have a long enough track record of consistent returns. In the last year, only one ESG mutual fund has returned gains. The rest lost between 4% and 15%, as on Sept. 28. Barring two schemes, all performed worse than the benchmark Nifty 50 and the broader Nifty 500. 

To be sure, markets have been volatile due to rising inflation, central bank tightening and commodity price fluctuations.

"Whether retail investors really relate to ESG at this stage is a question mark," said Piyush Gupta, senior director at Crisil Ltd. Investors won't be willing to settle for weaker performance to achieve ESG compliance, he said.

Asset managers, however, said investors who are entering ESG have a different set of expectations. 

“More than the returns, investors who've come into ESG globally, their objective was to build a sustainable portfolio, one that is aligned with their world view," Patni said. "Those intangible things took a priority over performance."

Portfolio Concentration 

Another concern that retail investors have with ESG funds do not offer something radically different from existing investment options. 

Most of the funds' holdings are heavily dominated by banking, financial services, information technology and consumer staples stocks as these companies tend to score better on ESG. That's very similar to that of the benchmark Nifty 50. 

Patni said their options are limited as most businesses engaged in the green economy and sustainability are not well represented on the listed market. "And one way is to get exposure to global stocks in that space."

Over the next couple of years, with more regulatory streamlining around ESG, more renewable and new economy businesses will get listed. And that will widen the investable universe. Besides, funds will also have a track record of about three-four years allowing investors to judge them better, he said.   

Gupta, citing reclassification of mutual funds in 2017, suggested that the market regulator needs to have a separate sub-category for ESG funds. Currently, these schemes fall under the 'thematic' funds category. SEBI has already proposed for new norms to address this. 

According to Gupta, it's not really fair to judge the performance of ESG mutual funds with one- to two-year track record in comparison to traditional schemes that have been around for way longer. 

"Once we've seen this (ESG) over a full market cycle, we will have better insight. These things take a slightly longer timeframe to pay out," Patni said. "In India we are still in the early stage of the cycle. It is in the developing phase."