ESG investing in India - A complete guide

Environmental, Social, and Governance (ESG) investing is the latest buzz in the investment world. Wondering why?

One of the reasons is increased social awareness. ESG investing in India is gaining momentum as investors increasingly seek to align their portfolios with sustainable and ethical practices. This approach evaluates companies based on environmental impact, social responsibilities, and governance standards, offering a holistic view beyond traditional financial metrics.

The growing awareness of climate change, social equity, and corporate transparency has led to a surge in ESG-focused investments. It reflects a shift towards responsible and forward-thinking investment strategies. As the Indian market evolves, understanding ESG investing becomes crucial if you want to achieve both financial returns and leave a positive societal impact. So, let’s decode the concept.

What is ESG investing?
 

ESG investing is about making investment choices that go beyond just profits. It evaluates companies based on three key factors—

1. Environmental – How businesses impact the environment.
2. Social – How businesses treat their employees and the community as a whole.
3. Governance – Whether businesses maintain ethical leadership.

Unlike traditional investing, which focuses only on financial returns, ESG investing considers long-term sustainability and risk management.

Companies with strong ESG practices tend to have better reputations and lower risks. They focus on reducing carbon emissions, ensuring fair workplace policies, and maintaining transparent corporate governance. This helps them build resilience against regulatory changes and reputational damage. On the other hand, companies with weak ESG frameworks face higher risks, including financial instability and potential losses.

Why invest in ESG?
 

ESG investing in India is gaining traction due to growing investor awareness and policy reforms.

1. Prioritising environmental sustainability

As the country shifts towards a greener economy, sustainability has become a priority. Under the Paris Agreement, India pledged to invest $2.5 trillion between 2015 and 2030 to meet climate goals. Additionally, India is committed to the Sustainable Development Goals (SDGs), ensuring economic growth without harming the environment.

2. Popularity among international investors

Global investors are also eyeing India’s ESG potential. The Global Sustainable Investment Alliance (GSIA) reports that 41 international ESG funds have allocated an average of 25% of their investments to Indian equities. This indicates growing confidence in India's sustainable business landscape.

3. Innovations by Indian companies

Domestically, major players like Quantum Asset Management have launched ESG-focused funds. In 2019, Quantum introduced India’s first open-ended ESG fund, and Avendus followed with another ESG-based fund. These developments highlight the rising interest in responsible investing.

4. Government policies

Government policies are further driving ESG adoption. India has introduced reforms to boost renewable energy investments and ensure ethical corporate behaviour. SEBI has also mandated ESG disclosures for the top 1,000 listed companies, increasing transparency and accountability.

5. Ease of tracking performance

Tracking ESG performance has become easier with sustainability indices like the NIFTY 100 ESG Index and the S&P BSE 100 ESG Index. These benchmarks help investors measure companies' environmental and social impact, making it easier to make informed decisions.

Types of ESG investments
 

Different types of ESG investments cater to various investor preferences. In India, ESG funds are primarily classified into the following types –

1. Exclusionary ESG funds

These funds avoid companies involved in harmful industries such as tobacco, alcohol, gambling, or fossil fuels. For instance, Quantum India ESG Equity Fund follows this approach by eliminating companies that do not meet its sustainability criteria.

2. Thematic ESG funds

These funds focus on ESG-related themes like clean energy, water conservation, and sustainable agriculture. One example is the Avendus India ESG Fund, which invests in businesses with environmental and social causes.

3. Best-in-class ESG funds

These funds invest in companies with top ESG ratings within their industry. They don’t exclude entire sectors but pick the best-performing firms in terms of ESG compliance.

4. Impact investing funds

These funds target businesses that generate measurable positive environmental or social impact, such as renewable energy projects or microfinance initiatives.

Financial performance of ESG investing in India
 

ESG investments in India have seen both enthusiasm and challenges. Initially, there was a surge in ESG mutual funds as investors sought sustainable and responsible investment options. However, trends have shifted. Have a look at the performance of ESG investing in India in recent times -

1. ESG funds in India now hold a growing AUM of nearly ₹10,946 crores, reinforcing their resilience
2. A survey by the CFA Institute found that 60% of Indian investors consider ESG funds for their higher risk-adjusted returns, compared to just 29% globally
3. However, ESG-focused funds saw a net outflow of ₹891.53 crore in 2023, largely due to a global rally in defence stocks and renewed interest in fossil fuel companies. These sectors are typically excluded from ESG portfolios, which might have caused the outflow

Yet, the belief in ESG investing remains strong. Beyond ethical considerations, it aligns portfolios with the future growth of ESG investing trends. Short-term fluctuations may challenge ESG funds, but their long-term potential remains promising. As awareness and regulatory support grow, ESG funds are well-positioned to deliver both financial returns and sustainable impact.

Regulatory landscape for ESG investing in India
 

India's regulatory landscape for ESG investing has evolved significantly, reflecting a commitment to sustainable finance. SEBI has been proactive in this domain, proposing expanding the sustainable finance framework. This initiative aims to integrate ESG factors into financial decisions, promoting sustainable finance practices.

Tax implication of ESG investing (can be developed into an illustration)
 

In terms of tax implications, ESG funds in India are structured as equity mutual funds, following standard equity taxation rules. Similarly, if you invest in ESG-oriented shares, the tax rules will be the same. Here’s how your returns would be taxed –

1. Short-term capital gains (STCG) are taxed at 20% if held for less than 12 months as per section 111A of the Income Tax Act, 1961 (the Act)
2. Long-term capital gains (LTCG) allow tax exemption up to specified limits for holdings over 12 months. If your returns are up to ₹1.25 lakhs, no LTCG tax will be applicable. However, if returns exceed ₹1.25 lakhs, the excess returns would be taxed at 12.5% as per section 112A of the Act
3. ESG funds do not offer additional tax deductions under Section 80C, unlike ELSS Mutual Fund schemes
4. Dividends earned from ESG funds or stocks will be taxed as per income tax slab rates applicable to the respective person

Getting started with ESG investing
 

Starting with ESG investing is simple but requires careful planning. Here’s how you can begin –

1. Define your goals – Decide whether you’re investing for ethical reasons, long-term financial growth, or both.
2. Explore ESG funds – Look for mutual funds or ETFs that align with ESG principles. IDFC FIRST Bank offers a range of sustainable financial products worth exploring.
3. Check ESG ratings – Evaluate fund sustainability before investing.
4. Speak with an investment advisor – Consulting a financial expert can help you understand ESG investing trends based on your goals.
5. Diversify your portfolio – ESG funds should complement your existing investments to balance risks and returns.

Unlock the potential of ESG investing for a diversified portfolio
 

With growing awareness and regulatory support, now is the perfect time to explore ESG investment options. As demand for transparency and ethical practices rises, ESG investing is set to reshape the business landscape, fostering long-term growth and benefiting investors and society.

IDFC FIRST Bank offers a seamless digital investment platform that can make ESG investing in India a breeze. To begin your ESG investment journey, explore mutual funds and stock options. You can also open an IDFC FIRST Bank Savings Account and automate your investments for a disciplined approach.

Unlock the power and potential of ESG and add a touch of diversification to your portfolio!