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Should I include ESG or other new-age funds in my existing portfolio in my 40s?

In recent years, investors have become curious about new-age investment themes like ESG (Environmental, Social, and Governance) funds.

It's particularly difficult to invest when you're in your 40s. You must accomplish your short-term objectives, like as funding your child's school or purchasing a home, while making sure your long-term objectives, such as retirement, are on track. Therefore, it is essential to have an investment portfolio that represents asset allocation and risk diversification according to your stage of life and goals.

It's nothing new to include stock, fixed income, or alternative assets like gold in a portfolio. Investors, however, have recently shown an interest in cutting-edge investment strategies like ESG (Environmental, Social, and Governance) funds.

Since these funds were introduced in India in 2018, their popularity has greatly risen. Although investing in sustainability themes through ESG funds is a positive shift, should you also check the ESG box? Let's investigate.

How does ESG investing work?

Theoretically, including ESG funds enables you to concentrate on sustainability and steer clear of businesses that harm the environment or exploit people. Environmental, social, and governance issues make up ESG.

Environmental: How resilient are corporate operations to hazards related to the environment and the climate, such as programmes to lower carbon footprints, conservation of soil and water, etc.

Social: A company's involvement with its stakeholders and the community, such as through equal pay for women and men, social charity, and fair salaries and labor policies.

Governance: How effective and capable is the executive team? For instance, staff leadership programs, audit openness, accountability, etc.

The ESG criteria of each fund differ based on their screening preferences.

Negative screening: With negative screening, undesirable traits are disregarded when making investments. For instance, refraining from funding a business that has an environmental impact that exceeds industry norms

Positive screening: This method involves investing in businesses that place a stronger priority on ESG factors, such as gender diversity and staff retention.

These tests and the associated ESG scores are crucial for choosing an appropriate ESG fund for your portfolio. They assist you in comparing the risks associated with investing in various funds and their exposure to ESG factors.

What should you consider for investing in ESG funds?

If you intend to include ESG funds in your portfolio, be sure to take your needs into account first as a responsible investor. Make sure the ESG funds you select bring value to your portfolio and reflect the same.

Companies that concentrate on non-financial factors that might not have an impact on the bottom line but will aid in overall growth make up ESG funds. You feel satisfied when you invest in businesses that uphold higher moral standards in their governance and give the environment and social development first priority.

ESG funds have increased sixfold in India during the past three years. According to data from Morningstar India, the fund size of ESG funds increased from Rs. 2,268 crores in March 2019 to Rs. 12,447 crores in March 2022.

Long-term, these factors can have a larger favorable impact on your portfolio than actual returns.

Shortfalls of ESG investing

Researching the level of diversification you may expect from the fund is preferable if diversification is your main objective for ESG investing. ESG funds can occasionally fail to truly diversify your portfolio.

For instance, the largest ESG fund in India is SBI Magnum Equity ESG Fund. Infosys, ICICI bank, HDFC bank, Larsen & Toubro Ltd, Mahindra & Mahindra Ltd, TCS, and other companies are among its top holdings. These companies already make up your existing holdings in these equities or large-cap mutual funds, if you have any.

ESG funds are also a new trend with few possibilities at the moment. They have yet to be proven, especially in light of how other fund categories have performed. Comparing ESG funds is additionally difficult due to the absence of a track record.

ESG ratings for funds are inconsistent, which makes it more challenging for the average investor to interpret the data. For instance, ISS QualityScore rates items from best to worst on a scale of 1 to 10, whereas CDP Climate Score rates items from worst to best on a scale of 1 to 8. Investors like you might find this rating system puzzling. You must trust the judgement and expertise of fund managers. You can also be at risk from greenwashing, which is the deceptive image of ESG adoption.

Conclusion: Should you include ESG funds in your portfolio?

Focus on the long-term possibilities if you want to add ESG funds in your portfolio. It might not just be about the profits but also about improving the state of the earth. In addition, you must take into consideration the state of your current portfolio, your investing options, your asset allocation plan, your long-term requirements, and your holdings of ESG funds. If you do decide to include ESG funds, make that decision after carefully taking your objectives, risk tolerance, and ideal asset allocation ratio into account.

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