Beyond Greenwashing: SEBI's Six ESG Strategies and the 80% Rule That Defines a 'Real' ESG Fund
SEBI's 20 July 2023 circular lets fund houses run multiple ESG schemes, but each must follow one of six named strategies and hold 80% of AUM to match. Here is how an exclusionary fund compares with a best-in-class fund, and how both are taxed.
When a fund house prints the word "ESG" on a scheme, an Indian investor since 20 July 2023 can now demand a precise answer to a once-slippery question: which of six defined strategies is this fund actually running, and can it prove that at least 80% of its money is deployed accordingly? That date is when the Securities and Exchange Board of India (SEBI) issued circular SEBI/HO/IMD/IMD-I-PoD1/P/CIR/2023/125, carving out a dedicated ESG sub-category under the thematic-equity umbrella and replacing a loose "one ESG scheme per fund house" allowance with a rules-based framework designed to curb greenwashing.
Before that circular, a fund house could launch only a single ESG scheme, and there was no mandated definition of what "ESG" had to mean inside the portfolio. Post-July 2023, an asset management company may run multiple ESG schemes, but each one must be launched under exactly one of six named strategies and must invest a minimum of 80% of its total assets under management in equity and equity-related instruments of companies that follow that chosen strategy. This article compares the two most philosophically opposite of those six approaches, an Exclusionary Strategy Fund and a Best-in-Class & Positive Screening Fund, so you can judge which structure fits a values-aligned equity goal.
The Six Strategies and the 80% Rule
SEBI's Annexure A to the 20 July 2023 circular lists six permissible ESG strategies, and a scheme's name must reflect the one it follows, for example "ABC ESG Exclusionary Strategy Fund". This naming discipline is the anti-greenwashing mechanism: an investor reading the scheme name should know the method before reading a single line of the offer document. The six strategies, each bound by the same 80% minimum-equity floor, are set out below.
| Strategy (SEBI Annexure A) | Core method | What it screens for |
|---|---|---|
| Exclusion | Negative screening | Removes sectors or firms failing a values or norms test (for example tobacco, controversial weapons) |
| Integration | Explicit ESG factor analysis | Blends ESG risk into conventional financial analysis |
| Best-in-class & Positive Screening | Ranking within a universe | Overweights the highest ESG-rated firms in each sector |
| Impact investing | Measurable outcomes | Targets defined social or environmental impact alongside return |
| Sustainable objectives | Theme alignment | Invests towards sustainability goals such as clean energy |
| Transition or transition-related | Decarbonisation trajectory | Backs firms credibly moving towards lower emissions |
Under the same circular, each ESG scheme must invest at least 80% of total AUM in the strategy it declares, and SEBI's framework requires the residual portion not to run counter to the scheme's stated ESG objective. Because every one of the six sits inside the thematic-equity structure, each is a thematic fund for regulatory and, as we will see, tax purposes. The 80% floor is what separates a "real" ESG fund from a conventionally managed equity scheme that merely markets itself with sustainability language.
Side-by-Side Comparison
An Exclusionary Strategy Fund starts from a universe and removes what fails a rule; a Best-in-Class & Positive Screening Fund starts from the same universe and ranks upward towards the leaders. Both must clear the 80% minimum-equity threshold set in the 20 July 2023 circular, but they express ESG conviction in opposite directions. The table below compares the two on the dimensions that decide real-world outcomes.
| Dimension | Exclusionary Strategy Fund | Best-in-Class & Positive Screening Fund |
|---|---|---|
| SEBI strategy label | Exclusion (Annexure A, strategy a) | Best-in-class & Positive Screening (Annexure A, strategy c) |
| Minimum equity in strategy | 80% of total AUM | 80% of total AUM |
| Portfolio construction | Removes disqualified firms, holds the rest | Overweights top ESG-rated firms per sector |
| Typical sector stance | May zero out entire sectors (for example tobacco) | Stays sector-diverse, tilts within each sector |
| Tracking versus broad market | Can deviate sharply if large sectors excluded | Usually closer to broad market weights |
| Regulatory category | Thematic-equity, ESG sub-category | Thematic-equity, ESG sub-category |
| Disclosure regime | BRSR Core assurance for holdings, per SEBI framework | BRSR Core assurance for holdings, per SEBI framework |
A practical consequence sits in that "tracking versus broad market" row. An exclusionary fund that removes, say, an entire high-emission sector representing a double-digit share of a broad benchmark index will, by design, diverge from that benchmark, and its year-to-year return can lead or lag the market by a wide margin. A best-in-class fund, holding leaders across every sector, tends to hug broad-market weights more closely, which historically produces a lower tracking error against a diversified index while still tilting the portfolio towards higher-rated firms. Neither is inherently superior; they answer different questions.
Both funds carry an ongoing expense ratio, and because these are actively managed thematic equity schemes rather than plain index trackers, their total expense ratios sit above those of passive funds. SEBI's cost-disclosure rules that took effect for the 2024 cycle require every scheme to show direct-plan and regular-plan costs side by side, so an investor comparing two ESG funds can read the fee gap before subscribing. You can model how a monthly commitment compounds under either fund using the SIP calculator, or test a one-time deployment with the lumpsum calculator.
It is worth stating plainly that an ESG scheme under this 2023 framework is not the same product as a tax-saving fund. An Equity Linked Savings Scheme carries a statutory three-year lock-in and a Section 80C deduction of up to Rs 1.5 lakh a year; a pure ESG thematic fund carries neither by default. If the goal is a deduction rather than a values screen, the ELSS calculator is the right tool, and the two decisions should be kept separate.
Tax Treatment
Because each of the six ESG strategies sits inside the thematic-equity category and holds a minimum of 80% in equity, comfortably above the 65% domestic-equity threshold, an ESG scheme is taxed as an equity-oriented fund. Following the changes announced in the Union Budget on 23 July 2024 and legislated through the Finance Act, the applicable rates for units sold on or after that date are set out below and confirmed by the Income Tax Department at incometax.gov.in.
| Holding period | Classification | Tax rate (FY 2025-26) | Key threshold |
|---|---|---|---|
| 12 months or less | Short-term capital gain (STCG) | 20% | No basic exemption on the gain |
| More than 12 months | Long-term capital gain (LTCG) | 12.5% | First Rs 1,25,000 of LTCG per year exempt |
The mechanics matter. If you hold either ESG fund for more than 12 months and realise a long-term gain of Rs 3,00,000 in a financial year, the first Rs 1,25,000 is exempt and the remaining Rs 1,75,000 is taxed at 12.5%, a liability of Rs 21,875 before cess. Sell within 12 months and the entire gain is short-term, taxed at 20%; the same Rs 3,00,000 gain would attract Rs 60,000 before cess, nearly triple the long-term figure, which is why the 12-month line is the single most expensive date in an equity investor's calendar.
Two clarifications prevent common errors. First, the Rs 1,25,000 LTCG exemption is an annual aggregate across all your equity funds and listed shares, not a per-scheme allowance, so holding both an exclusionary and a best-in-class fund does not double it. Second, dividends, where a scheme offers an income-distribution option, are added to your total income and taxed at your slab rate, and for the new tax regime in FY 2025-26 the Section 87A rebate now shelters resident individuals with total income up to Rs 12,00,000, with a maximum rebate of Rs 60,000. Surcharge on high incomes in the new regime is capped at 25%, not the older 37%.
Who Should Pick Which
The choice between the two structures is a choice about how you want your conviction expressed, and it maps cleanly onto investor profiles. An investor who holds firm moral lines, no tobacco, no controversial weapons, no thermal coal, is best served by an Exclusionary Strategy Fund, because negative screening under SEBI's strategy (a) is the only one of the six that guarantees the offending firms are absent rather than merely underweighted. The trade-off, established in the comparison table above, is a portfolio that can diverge meaningfully from a broad benchmark in any 12-month window.
An investor whose priority is sustainability leadership without abandoning diversification fits the Best-in-Class & Positive Screening Fund, strategy (c), which keeps exposure across sectors while tilting towards the top ESG-rated firms within each. This suits someone building a core equity allocation over a 7 to 10 year horizon who wants an ESG tilt but is uncomfortable with the concentration risk that full sector exclusion can create. Because both funds enforce the same 80% equity floor, the diversification difference comes from method, not from asset mix.
For an investor still deciding whether a dedicated ESG scheme belongs in the portfolio at all, the disciplined default is to size any thematic-equity position modestly, since AMFI-published categorisation treats thematic funds as concentrated bets rather than core holdings, and to run the core allocation through a diversified equity or index vehicle. A goal-based monthly plan can be stress-tested with the SIP calculator before committing capital, and the ESG sleeve can then be added as a satellite once the strategy label is understood.
FAQ
What exactly changed on 20 July 2023 for ESG mutual funds?
SEBI circular SEBI/HO/IMD/IMD-I-PoD1/P/CIR/2023/125, dated 20 July 2023, created a separate ESG sub-category within thematic-equity and allowed fund houses to run multiple ESG schemes instead of just one. Each scheme must now be launched under exactly one of six defined strategies and hold at least 80% of total AUM in line with that strategy.
What is the 80% rule?
Every ESG scheme launched under the 2023 framework must invest a minimum of 80% of its total AUM in equity and equity-related instruments of companies that follow the strategy the scheme has declared. The residual portion must not run counter to the scheme's stated ESG objective, which is what distinguishes a regulated ESG fund from a conventionally managed scheme using sustainability language in its marketing.
Are ESG funds taxed differently from other equity funds?
No. Because each ESG scheme holds at least 80% in equity, well above the 65% equity threshold for an equity-oriented fund, it is taxed like any other equity fund. For units sold on or after 23 July 2024, STCG on holdings of 12 months or less is 20%, and LTCG on holdings beyond 12 months is 12.5% with the first Rs 1,25,000 of LTCG per year exempt.
Does an ESG fund give a Section 80C deduction?
Not by default. A Section 80C deduction of up to Rs 1.5 lakh a year, with a three-year lock-in, applies to an Equity Linked Savings Scheme, not to a general ESG thematic fund. An ESG scheme and an ELSS are separate products, and only the latter is designed as a tax-saving instrument.
How do I tell which ESG strategy a fund follows?
Read the scheme name. SEBI's 2023 circular requires the name to reflect the chosen strategy, for example "ABC ESG Exclusionary Strategy Fund" or a best-in-class equivalent, so the method is disclosed before the offer document. The six permitted strategies are Exclusion, Integration, Best-in-class & Positive Screening, Impact investing, Sustainable objectives, and Transition or transition-related investments.
Is a best-in-class fund safer than an exclusionary fund?
Neither is "safer" in a regulatory sense; both are thematic-equity schemes and carry equity-market risk. A best-in-class fund usually stays closer to broad-market sector weights and so tends to show a lower tracking error against a diversified index, while an exclusionary fund can diverge sharply if it removes large sectors. The right choice depends on whether you prioritise diversification or hard exclusion.
How much of my portfolio should an ESG thematic fund be?
There is no fixed regulatory cap, but AMFI-published categorisation treats thematic funds as concentrated, non-core exposures. A common discipline is to build the core allocation through a diversified equity or index vehicle and add an ESG sleeve as a satellite, sized modestly, after confirming the scheme's declared strategy and its 80% commitment.