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Introducing an ESG+Factor Strategy for the Eurozone

Feb. 04, 2019

Feb. 04, 2019

Photo: iStock.

 

STOXX has launched the Eurozone’s first set of indices combining a factor strategy with responsible-investing screens that meet the standard sustainable policies of investors.

The EURO STOXX® ESG-X & Ex Nuclear Power Single Factor Indices and the EURO iSTOXX® ESG-X & Ex Nuclear Power Multi Factor Index are designed to exploit sources of market-excess returns, so-called risk premia, while filtering out companies deemed in contravention of environmental, social and governance (ESG) principles. The EURO STOXX® ESG-X & Ex Nuclear Power Minimum Variance Unconstrained Index, in turn, targets the same responsible approach while seeking to lower the portfolio’s volatility.

The indices lie at the crossroads of two strong investment trends that have garnered growing assets and momentum in recent years: sustainability-based strategies on the one hand, and the passive and systematic exploitation of risk premia on the other. Around one in five investors in a surveylast July said they plan to increase their allocation to such a combination of strategies over the next two years.

Norm- and product-based exclusions

The ESG screens will remove companies based on norms (United Nations Global Compact principles) and products (controversial weapons, tobacco, thermal coal and nuclear energy). Negative or exclusionary screening is the most popular ESG strategy among asset owners and managers.2

The single factor indices aim to extract the following sources of risk premia: value, quality (leverage and profitability) and momentum. The multi-factor index seeks to diversify across the factors of profitability, earnings yield, leverage, value and low volatility.3

The EURO STOXX ESG-X & Ex Nuclear Power Minimum Variance Unconstrained Index tracks stocks that have exhibited the lowest individual levels of historical volatility but is optimized to account for sector and country biases and intra-stock correlation to avoid unwanted exposure and style concentrations.

All indices control for risk and focus on tradability.

STOXX’s Minimum Variance Indices come in two versions: constrained and unconstrained. The former has a similar exposure to a market-cap-weighted index but with lower risk. The unconstrained version, on the other hand, has more freedom to fulfil its minimum variance mandate within the same universe of stocks.

Open architecture

The new indices are enabled by STOXX’s open architecture, where we collaborate with leading data providers in various fields. In this instance, Sustainalytics provides the ESG filters, while Axioma has developed the factor exposure analysis and optimization processes. 

Three pillars of modern investing

Factor investing has grown in popularity since the first sources of market-excess systematic risk were popularly documented in the 1990s. A large body of empirical results points to significant alpha from these factors relative to market-cap-weighted benchmarks. Passive factor-based strategies have taken up a large proportion of new investments as a transparent and low-cost way to target those risk premia. 

Separately, ESG has seen strong demand in recent years as more asset owners embrace sustainable and fair policies, while data show that aligning portfolios with responsible criteria need not mean giving up on returns.

Low-volatility strategies have also proved popular in the aftermath of the global financial crisis and during more recent market sell-offs. Minimum variance indices have outperformed benchmarks both during periods of heightened volatility but also in the long term, as they avoid the broader market’s worst drawdowns, aiding compound growth.4

A liquid Eurozone universe

The universe for the new indices is the EURO STOXX® Index, which currently has 307 components. Their weightings are defined by an optimization process that upholds the respective single-factor, multi-factor and minimum-variance strategy. The indices are constrained for liquidity and weight as well as for country, industry and sector exposure to keep a similar structure to the benchmark.  

For more information, please visit the methodology guides for the single and multi-factor indices. 

The indices will serve as underlying for respective exchange-traded funds (ETFs) to be issued by UniCredit. 

Investment possibilities continue to expand 

This latest addition to the STOXX family embodies the targeted possibilities of indexing, with the new indices offering a sharpened strategy that combines the potential of outperformance, diversification and stability with the standard requirements of responsible investment policies. 

 

Featured Indices

EURO iSTOXX® ESG-X & Ex Nuclear Power Multi Factor Index

EURO STOXX® ESG-X & Ex Nuclear Power Minimum Variance Unconstrained Index

EURO STOXX® ESG-X & Ex Nuclear Power Value Index

EURO STOXX® ESG-X & Ex Nuclear Power Momentum Index

EURO STOXX® ESG-X & Ex Nuclear Power Quality

 

Sustainalytics, Smith School of Enterprise and the Environment (University of Oxford), Aberdeen Standard Investments, ‘Smart beta and ESG,’ July 2018. 

Eurosif, ‘European SRI Study 2018,’ Nov. 19, 2018. 

Low volatility is accomplished through a minimum variance objective. 

STOXX, ‘Building Minimum Variance Portfolios with Low Risk, Low Drawdowns and Strong Returns,’ September 2016.  

 

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