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Mutual Funds

Kotak ESG Opportunities Fund NFO: Should you invest?

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Kotak Mahindra Mutual Fund has launched an NFO (New Fund Offering) for an active equity fund called the Kotak ESG Opportunities Fund. The NFO is open from 20th Nov to 4th Dec 2020. We took a look to see if it makes sense for investors.

Short Answer: No. We think ESG is a convenient marketing label that allows the fund house to offer yet another actively managed fund with little differentiation from existing funds. Investors should just give this a miss.

Read on for our take on the Kotak ESG Opportunities Fund NFO.


ESG: The not-so-new kid on the block

A quick primer on what ESG investing is about. ESG stands for Environment, Society, and Governance. ESG Investing is therefore about investing in, or rather eliminating companies that, through the course of their business, demonstrate negative environmental or societal impact. The hypothesis is that socially responsible, environmentally-friendly, ethical firms deliver superior risk-adjusted returns compared to the market.

This idea has been around for decades and has been long adopted by large pension funds as one of the criteria for their asset managers to consider. This means assets worth Trillions of USD are managed with some reference to the ESG theme.

Where there is demand, there is supply. Not surprisingly, the NSE has two ESG Indices called the NIFTY 100 ESG Index, and the NIFTY 100 Enhanced ESG Index.

Here’s how the NIFTY 100 ESG index picks companies:

  • Designed to reflect the performance of companies that are part of NIFTY 100 index, based on Environmental, Social and Governance score
  • The companies that are involved in any major Environmental, Social or Governance controversy shall not be considered for selection in the index
  • Companies engaged in the business of tobacco, alcohol, controversial weapons and gambling operations shall be excluded
  • Sector weights are based on free float market cap. Each index constituent within sector is tilt weighted based on ESG score and is capped at 10%

Kotak Mahindra ESG Opportunities Fund in a nutshell

The new fund from Kotak is an active equity fund that will benchmark against the NIFTY 100 ESG Index.

From the Scheme Information Document:

Investment Objective: “The scheme shall seek to generate capital appreciation by investing in a diversified portfolio of companies that follow Environmental, Social and Governance parameters.”

Investment Strategies:

“The scheme will, through internal diligence and/or in consultation with external advisors, identify stocks which have an ESG orientation in the opinion of the fund manager.

ESG stands for Environmental, Social and Governance. These ESG factors offer fund manager added insight into the quality of a company’s management, culture, risk profile and other characteristics.

For the purpose of this scheme, such companies would be considered as falling within the ESG ambit which have prudent policy, process and practice with regard to environment, social development and corporate governance. External data providers may be used to understand ESG parameters and get scores for companies. For companies which lack such data, the fund manager and research analysts may engage with the company directly to seek more clarity on ESG parameters before deciding on its inclusion in the universe. The fund manager would be guided by ESG scores but not restrained by them and can use his discretion to decide on companies which are long term sustainable businesses with good ESG practices.

Based on the ESG criterion, the fund manager would identify a list of companies. The final selection of stocks & sectors would be driven primarily by the growth prospects and valuations of the businesses over a medium to long term as per the discretion of the fund manager within this universe.”

ESG Performance (NIFTY 100 ESG Index) vs NIFTY:

Kotak ESG Opportunities Fund NFO: Should you invest?

Source: Fund Presentation

Should you invest in the Kotak ESG Opportunities Fund?

Absolutely Not. Here’s why.

ESG here is a marketing tool

A story goes that back in 1996, Sachin Tendulkar refused a lucrative bat sponsorship contract because his father had advised him to stay away from endorsing tobacco and liquor brands.

Who wouldn’t want to feel like they are doing the right thing? Especially if doing the right thing is rewarded with market-beating returns as shown in that chart above from the product presentation? We’ll come to the supposed returns in a minute but first let’s stay on the idea of investing in companies that benefit society, the environment, and are ethical.

Being able to tell whether a company is cumulatively beneficial or harmful along varied parameters that come under ESG should be a daunting task. The Kotak presentation lists the following parameters

Kotak ESG Opportunities Fund NFO: Should you invest?

Source: Product page

Sounds comprehensive. But doing justice to even a subset of listed companies on all those parameters would need thousands of person hours. Kotak will spend precisely zero hours on what is the core principle of the fund.

Enter Sustainalytics. This is a Morningstar company that is the torch-bearer for ESG investing globally. They issue ESG scores to any company in the world by gathering data, crunching the numbers, and scoring them on a scale of 0 to 100. Higher the score, higher the risk from an ESG perspective.

An investment strategy that depends on a 3rd party scoring tool that itself relies on self-reported data and is available to whoever signs up. Does not sound like a recipe for market-beating returns.

The ESG Score blackbox

Here’s HDFC Bank’s ESG Score

Kotak ESG Opportunities Fund NFO: Should you invest?

Source: sustainalytics.com

And here’s ITC’s ESG Score

Kotak ESG Opportunities Fund NFO: Should you invest?

Source: sustainalytics.com

Remember, lower the score, lower the risk, better the ESG performance of the company.

Maybe there is a logical reason why a company that also manufactures habit-forming cancer-causing products scores almost identical (slightly better in fact) to a bank.

Given anyone trying to gather this information has to rely on voluntarily supplied data, one can’t help but wonder if the score itself might be a massive data-collation spreadsheet exercise that is in fact not very useful.

Can’t help but think of Goodhart’s Law when considering composite scores that then become the basis for investing decisions:

“When a measure becomes a target, it ceases to be a good measure.”

More of the same

The NIFTY 100 ESG index was instituted in March 2018, and was back-filled to base year of 2011. The theoretical version of the index outperformed in 6 of the 6 years while the actual index has outperformed in 1 out of 2 years since. Not a convincing argument about the superiority of ESG investing in India.

The graphic below is how the fund will actually pick stocks.

Kotak ESG Opportunities Fund NFO: Should you invest?

Source: Product page

Note the emphasis on the proprietary Business, Management & Valuation approach. Which is another way of saying the same approach applied to the other active funds, will also be applied to this new fund.

In that case, is this any different, and why shouldn’t an investor just consider those?

Should I invest in this NFO?

No.

A new fund with a catchy label but little differentiation under the hood suggests a “shiny new thing” marketing exercise.

Shorn of the ESG label which we don’t think adds much to the investment process, the fund looks like just like any other active equity fund in the Kotak stable. There are other better multicap funds with proven performance and track record investors should consider instead.


Disclaimer: Since we are active asset managers running a PMS, with quantitative and bottom-up fundamental portfolios, our views on equity and other mutual funds will reflect our bias.

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