ESG funds promised a new way to invest: put your money only into companies that follow strong environmental, social, and governance (ESG) practices.
In theory, this meant cleaner businesses, ethical practices, stronger boards, and more transparency.
For investors, the appeal was earning returns without supporting companies that harm the environment or ignore social responsibility.
But in India, the reality has been mixed.
A few ESG schemes exist, disclosures have improved, and global interest has slowed.
Regulators have also raised questions about the reliability of ESG ratings.
To decide if ESG funds belong in your portfolio, it helps to understand what they really offer today.
How ESG Funds Are Supposed to Work
ESG funds evaluate companies based on three broad criteria:
Environmental (E): Carbon emissions, water use, waste management, and other sustainability measures.
Social (S): Labour standards, diversity, community impact, and product safety.
Governance (G): Board structure, shareholder rights, transparency, and overall corporate governance.
Fund managers use public data and third-party ESG scores to avoid companies with high environmental or social risks.
Ideally, this creates a portfolio that is more resilient, less prone to shocks, and ethically aligned.
The Challenge of Inconsistent Ratings
One major issue is that ESG ratings are not standardized.
A company can receive a high score from one provider and a low score from another, depending on how each rating is calculated.
In India, sustainability disclosures are still evolving, so ESG data can feel incomplete or outdated.
Regulators are pushing for clearer rules and more reliable data, but the system is still developing.
This means investors may find it hard to know exactly what they’re buying in an ESG fund.
Performance Varies With Market Cycles
ESG funds often include large, high-quality companies. When markets favour these sectors, ESG funds can keep pace or even outperform.
However, in cycles where cyclical or carbon-intensive industries rally, ESG funds may lag because they avoid such stocks.
This doesn’t make ESG funds “bad,” but it does show that returns are tied to the types of companies the fund prefers.
Investors seeking stability and governance quality may find comfort, but those expecting automatic outperformance may be disappointed.
Should You Invest in ESG Funds?
ESG funds suit investors who:
Care about corporate behaviour and ethics
Want a portfolio with better governance
Already have a diversified portfolio and want a small, thematic allocation
They should not be your main equity investment.
The universe of eligible companies is still narrow, ratings are inconsistent, and performance can lag in certain markets.
ESG funds work best as a small “satellite” allocation, not the core of your portfolio.
How ESG Fits in an Indian Portfolio
A practical approach is to allocate 5–10% of your equity portfolio to ESG funds if you value the theme.
They offer exposure to companies with strong governance and ethical practices but are not guaranteed to beat the market or reduce volatility.
For long-term returns without thematic constraints, a diversified large-cap or flexi-cap fund is still the simpler choice.
Takeaway: ESG funds are a thoughtful addition, but the category is still evolving.
Use them to complement your portfolio, not define it.
Keep expectations realistic and treat ESG as an add-on rather than the centerpiece of your investment strategy.
