Should ESG funds be a part of your portfolio?

There is a pressure mounting on asset managers to pay attention to environmental, social and governance (ESG) issues of a company before selecting them to be a part of their portfolio. ESG has been gaining traction in the last few years among institutional investors. ESG factors will play a major role in determining the companies that are going to be a part of the portfolio of larger asset managers. It has been observed that the risk of ESG on a firm’s long-term financial prospects is often under-estimated. Therefore, these factors will start playing far more important considerations for investors in the coming days. Most of the current stock selection process gives greater attention to the governance issue. The interesting fact, however, is that some of the surveys show that, the perceived long-term value of environmental and social programs exceeds the value attributed to governance programs.

According to a report by MSCI, the companies with improving ESG credentials have, on an average, outperformed by 14.4 per cent in the emerging markets and 5.2 per cent in the developed markets over a period of five-years. Even in India, the recent performance of the index dedicated to ESG factors has performed better than the large-cap indices. In India, we do have Nifty 100 ESG TRI that has 88 companies, spread across 16 sectors. Financial services, IT, consumer goods, energy and automobile are the top five segments. In the last one month, when equity market witnessed a deep cut, Nifty 100 ESG has outperformed Nifty 50 and has fallen less.

In India, there are only three funds that are dedicated to the ESG theme. All of them have performed better than their benchmark. So, does this mean that they should be an essential part of your portfolio? Right now, we do not have much-required history to suggest you on whether you should have this fund in your portfolio or not.

However, we do have a short history of fewer than three years of these funds. In these three years, large-cap dedicated funds have performed better than other categories. ESG dedicated fund largely have companies from large-cap and hence, they might have performed better. Moreover, it also lacks the required diversity. Therefore, it is better to wait than adding ESG fund to your portfolio.