ESG funds: investing with a conscience, or paying for a label?

ESG funds ask you to hold two beliefs at once: that the portfolio reflects your values, and that it will not cost you money. Both claims deserve scrutiny, and in India there is now a rulebook you can check them against — which is more than most markets can say.

What the letters mean

Environmental — emissions, water, waste, energy transition risk. Social — labour practices, safety, community, supply chain. Governance — board independence, promoter behaviour, related-party transactions, minority shareholder treatment.

In the Indian context the G is doing most of the work. Governance failures — promoter pledging, siphoning through related parties, opaque holding structures — have destroyed far more retail wealth here than environmental liabilities have. A fund that genuinely screens on governance is applying a quality filter with a long history of paying for itself. That is a stronger argument for the category than the environmental one, and it is rarely the argument in the brochure.

India's rules are unusually specific

Most markets let a fund call itself ESG on its own say-so. SEBI does not.

Six defined sub-categories. An ESG scheme must declare its strategy from a fixed list: exclusion, integration, best-in-class and positive screening, impact investing, sustainable objectives, and transition-related investments. These are genuinely different products. An exclusion fund merely avoids tobacco and coal; an impact fund is trying to cause an outcome. Knowing which one you own is the first question.

A minimum equity floor. At least 80% of assets must be in equity aligned with the declared strategy.

And the anti-greenwashing rule that actually bites: at least 65% of AUM must be invested in companies that report on comprehensive BRSR and obtain assurance on their BRSR Core disclosures. The remainder may sit in companies with BRSR disclosures.

That last one is the important one, because it moves the test from what the fund manager claims to what the underlying company has had independently assured. BRSR Core assurance has been phased in by company size — extending through the top 500 and then the top 1,000 listed entities — which has a side-effect worth knowing: the assurance requirement mechanically pushes ESG portfolios towards large caps, because those are the companies inside the assurance net.

⚠️ These thresholds and the assurance phase-in have moved more than once. Check the scheme information document and the current SEBI circular before relying on any figure here.

Is it greenwashing?

Sometimes, and the honest test is not the marketing but the portfolio.

Open the holdings and compare them with a broad index. If an ESG fund's top fifteen names are largely the index's top fifteen names, you are paying an active fee for the index with a label attached. This happens easily, because in India the large, well-governed, well-disclosed companies are also the biggest index constituents. Check R² and tracking error: a very high R² and a very low tracking error against a broad index is the signature of a closet index fund.

Ask what it excludes and what that costs. A fund that excludes energy, tobacco and metals has made a large, permanent sector bet. In a year when energy leads the market, it will lag badly — and that is the fund working correctly, not failing. The exclusion is the product.

Watch for ratings disagreement. ESG scores from different providers correlate far less than credit ratings do; two agencies frequently reach opposite conclusions about the same company. Any fund resting its process on a single third-party score has outsourced the judgement to a number with wide error bars.

Does it cost return?

The theoretically honest answer: any constraint on the investable universe can only reduce the maximum achievable return, and may or may not reduce the realised one. Excluding a sector removes both its worst outcomes and its best.

Empirically the results are mixed and heavily period-dependent — ESG strategies looked excellent through the 2019–21 growth run and poor through the 2022 energy rally, which is the same cycle story as any other style tilt. Do not let a three-year comparison decide anything.

What is more defensible is the narrower claim: governance screening tends to avoid permanent capital loss. Avoiding the frauds is worth a great deal precisely because those losses do not come back.

If you want to own one

• Read the declared sub-category first. Exclusion and impact are different products with different return profiles.
• Compare the portfolio against a broad index before paying an active fee.
• Size it as a satellite unless you are prepared to accept the sector bet as a core position.
• Judge it against ESG peers and across a full cycle, not against the index in the year energy ran.
• Accept the trade honestly: you may be paying something for the alignment, and that can be a perfectly rational thing to pay for. It just should not be sold to you as free.

Pitfalls to avoid

• Assuming ESG means low risk. It means a constrained universe. Constraints concentrate as often as they protect.
• Buying the label without reading the strategy. Six sub-categories are not interchangeable.
• Ignoring the sector bet. Excluding energy and metals is a permanent macro position, whatever it is called.
• Comparing to a broad index over a short window. The exclusions guarantee divergence; the direction depends entirely on which sectors led.
• Paying an active fee for index-like holdings. Check the overlap before you subscribe.
• Treating an ESG score as a fact. Providers disagree substantially about the same company.

Key takeaway

India's ESG rules are stricter than most — six declared strategies, an 80% equity floor, and a 65% requirement to hold companies with assured BRSR Core disclosures, which shifts the test from a manager's claim to an audited fact. That makes outright greenwashing harder, but it does not answer the two questions that decide whether one belongs in your portfolio: is this portfolio meaningfully different from an index, and is the sector bet inside it one I want permanently? Read the holdings, size it as a satellite, and treat any return claim over a three-year window as a statement about which sectors led, not about the strategy.