Globally, ESG investments continue to rise. ESG assets are on track to exceed $53 trillion by 2025 and represent more than a third of the $140.5 trillion in projected total assets under management (AuM), according to Bloomberg Intelligence. Increased investor demand, emerging regulatory requirements, and the launch of several ESG funds have fueled a surge in ESG-focused asset allocations.

The Indian investment management industry has also seen the launch of nine ESG-focused funds in the last few years. It is still early days, but what can we say about this class of funds, in terms of investment objectives or how they integrate ESG issues in their investment process?

A recent study done by CFA Society India and CFA Institute on Indian ESG funds suggest that the ESG integration practices are understandably in relative infancy, and wide variability exists across ESG funds w.r.t their investment approaches, ESG scoring methodology and outcomes. For example, the number of stocks in these funds ranged between 23 and 54, and many funds held a significant portion of assets outside their benchmark universe as of November 2021. They also had varying exposure to carbon intensive sectors like oil and gas, with some funds exceeding the exposure vis-à-vis their benchmark.

What explains this variability? One reason is the variation in ESG ratings, whether based on internal analysis or sourced from third-party providers. The rating disagreements, in turn, reflect the heterogeneous views among market practitioners about which factors are important in assessing the ESG performance of a company. It may be impractical and undesirable to impose homogenous views on ESG, but it is important for managers to be able to document and communicate reasons for disagreement, especially for those stocks in the fund which are not part of the benchmark.

There are also challenges with respect to issuer level disclosures. SEBI’s business responsibility and sustainability reporting (BRSR) mandates companies to produce an array of metrics, but there are definitional issues which makes comparisons difficult. For example, when companies say they derive a portion of energy from renewable sources, they could mean either just electricity, or include fuels used in production. There are also interpretational issues – if one company reports increasing sexual harassment complaints, and another reports no complaints year after year, does it mean the latter is doing better, or is it a reflection of a more open culture of reporting in the former? It is possible to improve definitions over time, but the interpretations will always remain somewhat subjective.

In addition to BRSR, SEBI has proposed a number of ESG rules recently, relating to the improvement of ESG integration practices, ESG rating providers, firm level policies, and disclosures by ESG funds in India.

However, there is a potential concern that the supply of ESG products and enabling regulations have raced ahead of investor demand. Globally, asset owners like pension funds have been vociferous supporters of ESG investing, but in India their voice is still largely absent from the conversation. What about retail investors? According to a recent CFA Institute global survey of retail and institutional investors, 60% of Indian investors (sample of 200 retail and 75 institutional investors) cited higher risk-adjusted returns as the primary reason for investing in ESG funds, far higher than global sample (29%), and only 30% expressed personal values or making a positive impact as a reason for investing in ESG funds.

To generate and sustain the growth of ESG investing, there is a need for focused investor education. Investment advisors should work with investors to identify their ESG and financial preferences when recommending ESG products. Investors should do their own research and understand the investment objectives and features when investing in such products.