Are non-ESG funds better than ESG funds at their game?

CRISIL ran ESG filters across 354 schemes across 16 categories. Some categories did well, others did not. Some funds did better on the E and S, but did poorly on the G parameter.

August 02, 2022 / 06:09 AM IST

The soaring popularity of environmental, social and governance (ESG) funds in recent years presents a compelling case for incorporation of ESG fund-scoring by the fund management industry in India.

There has been a surge in sustainable assets globally, especially in the US, where nearly 33 per cent, or $17.1 trillion of the total $51.4 trillion assets under management (AUM) as of 2020, was in this segment.

Pension funds had the lion’s share of this, with nearly $6.2 trillion of their assets in the US as of 2020 being in the ESG space. Mutual funds with ESG criteria in their investment strategy totalled another $3.1 trillion.

Back home, it is only recently that such funds have gained currency. The combined AUM of the 10 ESG funds currently in operation was Rs 11,818 crore as on March 31, 2022 (excluding fund of funds), having risen five-fold over the past three years. As many as seven of these were started in fiscal 2021.

The growth is being driven by special investment vehicles in the ESG segment and an increasing preference of underlying companies for a sustainable, long-term approach to growth, which is adding to the share of sustainable assets managed by mutual funds.

Widespread adoption of ESG-scoring by mutual funds at this stage will add much-needed grist to the mill by increasing transparency and trust.

After all, mitigating ESG risk makes for prudent investment management, as it involves identification of companies with sustainable practices across the three parameters, thereby improving their long-term value proposition.

These factors improve disclosures in the space among companies and also foster a stewardship code between investors and investee companies, that protects shareholders.

Gauging the ESG quotient of Indian funds

A CRISIL Research analysis of mutual funds in the country, covering 354 schemes across 16 categories — (10 equity and six debt schemes) — with assets under management totalling Rs 17.69 lakh crore as on February 28, 2022, threw up some interesting facts.

Significant monies were in firms with good ESG scores, with exposure to ‘Leadership’, ‘Strong’ and ‘Adequate’ categories at Rs 2.29 lakh crore, Rs 5.22 lakh crore and Rs 6.46 lakh crore, respectively. Allocations to firms in the ‘Weak’ and ‘Below Average’ categories totalled just Rs 66,777 crore.

All equity categories, except small-cap and mid-cap, had higher median scores than debt categories. Within the equity category, large-caps had the highest median scores, benefitting from their mandate of selecting blue-chip companies and having exposure to sectors with high ESG scores, such as banks and software.

The small-cap category had the lowest median score, hamstrung by exposure to sectors with low ESG scores, such as specialty chemicals and auto ancillaries.

On average, large-cap companies had a score of 61 as against 52 for small-caps. The difference on the G parameter was narrow, with the score at 69 for large-cap firms versus 66 for small-caps. However, small-cap companies lost out on the E and S parameters, with scores of 40 and 47 compared to 54 and 57 respectively, for large-cap ones.

Sectors that scored low on ESG parameters, on average, included transport infrastructure, construction, EPC, and mining.

G parameter scores were higher than the E and S parameters for 97% of the schemes. Scores on the E parameter were the lowest for 86% of the schemes.

Somewhat curiously, there was a trade-off between diversification and better ESG scores. Equity schemes with more-than-average ESG scores generally exhibited lower diversification. On the other hand, funds with a lower-than-average ESG score had better-than-average diversification.

Large-cap, ELSS, flexicap, focused and value/contra categories had higher ESG scores but less-than-average diversification, while mid-cap, multi-cap and small-cap categories had a majority of funds with lower ESG scores but better diversification.

Analysis of ESG-themed funds showed that all but one had a higher score than the average across the equity categories considered, but lower diversification.

ESG fund scoring can be a win-win

The Securities Exchange Board of India’s (SEBI) rule on good governance, which kicked in from April 1 for the top 1,000 companies by market capitalisation to mandatorily include the Business Responsibility and Sustainability Report in their Annual Report, sets the stage for formal adoption of ESG for gauging corporate performance.

That, coupled with the current pace of growth, indicates ESG assets will only accelerate from here.

Adopting ESG fund-scoring in investment products such as mutual funds will improve sustainability disclosures, creating a win-win for investors and the industry.

Greater awareness of ESG among companies and asset managers will be of the essence here.

That said, it is important to ensure ESG is one of several components of portfolio construction and not the sole criterion, in order to avoid limitations from a developing concept, especially in a developing economy such as India.
Jiju Vidyadharan is Senior Director, CRISIL Research
first published: Aug 2, 2022 06:09 am
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