What is an ESG ETF? Environmental, Social, and Governance ETFs

With rapid changes in all aspects of life, the way investors invest has also changed. Today, investors not only focus on returns but also on the impact their money creates. Environmental, Social, and Governance (ESG) investing has grown in popularity as individuals and institutions try to invest responsibly. One of the ways to invest in ESG-compliant companies is through ESG Exchange Traded Funds (ETFs). In this article, let us understand what ESG ETFs are, how they work, and if they are suitable for your portfolio.

What Does ESG Stand For?

ESG stands for Environmental, Social, and Governance. These are the three key factors used to evaluate how responsible and ethical a company is.

• Environmental factors include how a company manages its carbon emissions, waste, and natural resources.
• Social factors focus on how the company treats its employees, customers, and communities.
• Governance refers to the company’s leadership structure, board diversity, and transparency in operations.

Companies that score well on these parameters are often seen as more sustainable in the long run. A sustainable company is not only beneficial for the environment but also for the general society.

What is an ESG ETF?

An ESG ETF is an exchange-traded fund that invests in companies meeting specific ESG criteria. Instead of picking individual stocks, an ESG ETF gives you exposure to a basket of ESG-compliant securities. These ETFs are traded on stock exchanges just like any other ETF.

They are designed to help investors benefit from investing activities while ensuring the companies that they invest in have a positive impact on the environment and society.

How Do ESG ETFs Work

Similar to other ETFs, ESG ETFs track ESG indexes. An ESG ETF invests in companies that have a similar proportion to the benchmark index. Through this, an ESF ETF can track and generate returns that closely match the underlying index.

The value of the ESG ETF rises or falls based on the performance of the companies included in the index. Investors can buy or sell units of the ETF during market hours just like shares.

Types of ESG ETFs

Benefits of ESG ETFs

There are several advantages of investing in an ESG ETF

• Through an ESG ETF, investors can invest in companies that benefit the environment as well as the wider community.
• ESG ETFs allow investors to align their ethical standards with their investment philosophy.
• Changes in government policies across the globe are advocating for higher ESG standards, making ESG ETFs an ideal long-term bet that also supports environmental and social sustainability.
• Investors can diversify their portfolio by investing in an ESG ETF. This allows investors to spread risk by gaining wider exposure to numerous companies.

Risks Associated with ESG ETFs

Similar to any other investment option, ESG ETFs also carry certain risks.

• ESG ETFs may narrow their focus on companies with high ESG ratings, which may limit diversification or impact growth.
• An ESG ETF typically invests in equities, and its performance is subject to market risks. The returns of ESG ETFs may be lower during market downturns.
• Company-specific risks, false reporting of ESG standards, and regulatory changes are other common risks associated with ESG investing.

ESG ETFs Available in India

Here are some of the ESG ETFs available in India -

• Nippon India Nifty 100 ESG Sector Leaders ETF
• Mirae Asset Nifty 100 ESG Sector Leaders ETF

ESG ETFs vs Traditional ETFs

How to Invest in ESG ETFs

Here’s how you can invest in ESG ETFs -

• Step 1: To invest in an ESG ETF, you need to open an account with a SEBI-registered broker or depository participant.
• Step 2: Choose an ESG ETF listed on Indian exchanges, review its expense ratio and holdings.
• Step 3: Through your trading platform, place an order for the ETF by entering the quantity and price.
• Step 4: After the ETF is credited to your demat account, you can monitor its performance.

Who Should Consider Investing in ESG ETFs

ESG ETFs may be suitable if you want to align your investments with your values while building long-term wealth. They can work well for investors who prefer low-cost, passive investing and are comfortable with moderate risk.

They might not be ideal if your primary focus is short-term returns or if you want exposure to all sectors without exclusions.

ESG ETF Performance: Should You Expect Lower Returns

There is a common belief that ESG ETFs might deliver lower returns due to their restricted scope of investment. However, the performance depends on the market cycle and the sectors included in the ETF. Various factors impact the performance of an ETF, and an ESG ETF may deliver returns on par with traditional ETFs.

ESG Indexes Used by ESG ETFs

Some common ESG indexes used by ESG ETFs in India include -

• Nifty 100 ESG Index
• Nifty 100 ESG Sector Leaders Index
• Nifty 100 Enhanced ESG Index
• S&P BSE 100 ESG Index
• S&P BSE 500 ESG Index

Conclusion

ESG ETFs are a way to combine responsible investing with the convenience of ETFs. They allow investors to support sustainable businesses while still aiming for returns. However, they are not entirely risk-free.

Before investing, understand how these ETFs work, compare them with traditional ETFs, and assess if they fit your investment goals and risk appetite.