Ethical investing means investing in businesses whose activities or policies align with one’s morals. It enables people to invest in establishments they find morally acceptable. This principled approach is steadily gaining traction across global financial markets, including India’s.  

This comprehensive guide analyses what ethical investing entails, key drivers encouraging its growth locally, types of sustainable investment funds available, and a step-by-step process for constructing a customised values-based portfolio.

What is Ethical Investing? 

Ethical investing incorporates environmental, social, and governance factors into investment analysis, decision-making, and regular financial metrics. The objective is to identify companies demonstrating responsibility across these aspects while delivering market-competitive shareholder returns.

Breaking Down ESG

The environmental, social and governance pillars in ESG investing involve evaluating a company’s performance on:

Environmental

• Climate impact and carbon emissions
• Energy efficiency 
• Waste and water management
• Biodiversity and deforestation
• Toxic emissions and pollutants
• Raw material sourcing
• Environmental regulations and risk management

Social

• Labour standards and working conditions
• Fair wage policies and income inequality
• Employee health, safety and wellbeing
• Diversity, equity and inclusion metrics
• Product quality, safety and social impact
• Human rights commitments 
• Community engagement and Philanthropy
• Supply chain audits for ethical sourcing
• Controversies related to racism, sexism, privacy issues, etc.

Governance

• Board structure, diversity and independence
• Executive compensation and accountability
• Political contributions and lobbying policies  
• Tax strategy and financial transparency
• Shareholder rights and disclosures

What’s Driving the Ethical Investing Trend in India?

The appeal for sustainable investing is rising across global markets, including the Indian share market. Several socioeconomic factors are catalysing this momentum locally:   

1. Greater ESG Awareness Among Investors

Indian investors, especially millennial and Gen Z demographics, are more cognisant of pressing ESG issues like climate change, social injustice and weak governance today. This motivates them to contribute through conscientious investments. Many Indian investors now consider sustainability while making investment decisions.  

2. Transfer of Wealth to Younger Generations

As younger Indians inherit wealth, they want to align family assets and inheritance with evolving social principles and environmental priorities. This is pulling more outstanding ethical capital into India’s investment ecosystem. Studies show that next-gen family business heirs rank ESG criteria among their top investment considerations.

3. Favourable Regulations 

Guidelines like BRSR (Business Responsibility and Sustainability Reporting) in India are nudging domestic companies to improve their ESG commitments. This expands the universe of ethical investment options available to local investors. Global reforms like the EU Sustainable Finance Disclosure Regulation also apply to foreign stocks in Indian portfolios.

4. Stronger Risk-Return Profile

According to several global studies, companies with better environmental, social, and governance (ESG) track records are more likely to provide higher returns per unit of risk taken over long periods. This data-backed proof and the success of ethical funds globally encourage more Indian investors to explore sustainable investment approaches.

5. Success of Global Ethical Investing  

The rising demand and total money invested in values-based funds across Europe, the United States, and the Asia Pacific region also generate interest among Indian investors.

Motivated by these trends, analysts predict assets directed towards sustainable investments within India could increase at an average rate of 30% yearly over the next 5 years. As ESG consciousness and ethical product options expand, a shift of investment capital towards sustainable funds awaits.

What are the Different Types of Ethical Funds in India?

Ethical funds in India are mainly categorised into four types:

1. Socially Responsible Investing Funds

SRI funds systematically avoid sectors like tobacco, alcohol, gambling, weapons, etc., to align investments with moral ideologies. They emphasise building moral portfolios based on investor ethics rather than ESG risk analysis. 

2. ESG Equity Funds 

ESG equity funds rigorously integrate analysis of material E, S and G factors alongside regular financial analysis to pick stocks. By minimising ESG risks, they aim to enhance portfolio returns. 

3. Impact Investing Funds

Impact funds target measurable positive social change or environmental impact alongside financial gains. They do this by funding early-stage social enterprises that address challenges like healthcare access, clean energy, food security, etc. Here, social/environmental returns take priority over financial returns. 

4. Faith-based Funds

These funds build portfolios that stringently comply with ideologies, values or exclusions mandated by various religions and faiths. As a result, sin stocks like alcohol, tobacco, adult entertainment, etc., get excluded irrespective of prospects.

How to Build an Ethical Investment Portfolio 

Follow these six steps to construct a customised ethical investment portfolio aligned with your sustainability values and financial objectives:

1. Self-Reflect on Your Principles

Analyse your ethical stance and positions on various ESG issues to determine alignment areas and exclusions for potential investments.  

2. Set Sustainable Investing Goals

Define your targeted financial returns, risk appetite and intended sustainability impact through ethical investing over various timeframes.

3. Research Fund Strategies

Based on your principles, understand the sustainable investment philosophies and stock/bond selection criteria followed by different mutual funds in India.   

4. Assess Fund Composition  

Scan shortlisted funds’ historical and current holding patterns to gauge portfolio-level ESG risk exposure.

5. Allocate Capital Strategically

Divide capital between funds matching your material ESG priorities and return expectations.

6. Track & Realign Regularly   

Review holdings, performance benchmarks and strategy changes in chosen funds annually to realign capital if needed.  

What are the Key Benefits of Ethical Investing? 

Alongside peace of mind from investing responsibly as per your values, sustainable portfolios offer several advantages:

1. Mitigate ESG Risk Exposure

By avoiding sin sectors and incorporating ecological, social and governance risks, ethical funds protect investments from lawsuits, scandals, climate disruptions, etc., faced by unethical companies.  

2. Tap Growth Potential in Green Industries

Sustainable funds channel more capital towards promising industries, such as renewable energy, green technology, organic food, etc., which are expected to grow exponentially in the coming decades.

3. Improve Risk-Adjusted Returns

Portfolios tilted towards high ESG scorers tend to deliver higher returns per unit of investment risk over long-term horizons.  

4. Gain Tax Incentives

Certain ethical funds provide tax rebates under Section 80C of the Income Tax Act on investments held for 3+ years.

5. Align Investments with Your Ethics

Ethical investing enables the channelling of hard-earned savings into companies that reflect your values, principles, and vision for society.

6. Create Real-World Social & Environmental Impact

Funding socially responsible businesses through SRI and impact, funds incentivises corporations to adopt eco-friendly and fair policies benefiting communities.

Sustainable investing allows you to earn profits ethically while contributing towards a just, resilient future.  

Conclusion

As evident, ethical or values-based investing currently offers a compelling proposition for investors in India. Given rising ESG consciousness locally alongside supportive regulations, sustainable investment funds are primed for robust 30%+ growth over the next 5 years.  

With the increasing interest in sustainable investment options and the upcoming IPO of ethical companies, sustainable investing is poised to become an even more critical part of India’s financial landscape.