ESG: Changing Portfolios and the World
Investing in Environmental, Social and Governance (ESG) strategies has swept across the asset-management industry, moving from niche to mainstream in just over a decade.
That trajectory may now gather pace as ESG interest spreads beyond large institutional investors, and the industry overcomes a “disjointed array of investment approaches and lower risk-adjusted performance,” according to Shundrawn A. Thomas, head of funds and managed accounts at Northern Trust.
“There is increasing appetite in the mainstream investor marketplace for ESG products,” Thomas says in the latest PULSE Fall/Winter issue. “Whether because of principles or because of risk-reduction objectives.”
Thomas is joined in an article by Rod Jones, head of STOXX’s North American business, in discussing the drivers and outlook for sustainability index investing. Northern Trust’s FlexShares this year launched two exchange-traded funds that track, respectively, the STOXX® Global ESG Impact Index and the STOXX® USA ESG Impact Index.
An entire range of ESG offerings
The realization that socially responsible investing (SRI) is not only about ethics and values, but also about improving long-term returns and minimizing tail risk, has lured meaningful investor interest.
Starting from its foray into the field of sustainability in 2001, STOXX now has around 60 indices that enable investors to incorporate a wide range of SRI factors into their investment processes.
In 2011, STOXX opened a new chapter in sustainable indexing with the STOXX® Global ESG Leaders index family. In 2016, the STOXX® Low Carbon Indices were introduced to help investors reduce the carbon emission footprint of, and risk within, their portfolios.
“Response to the whole suite of ESG indices at STOXX has been strong,” Jones says in the article. “The scope of possibilities to adjust ESG strategies to each investor’s goals and mandate, is a big driver spurring interest.”
Impacting investment risk and returns
With innovation in indexing and factor investing, ESG opens up new possibilities.
In July 2016, STOXX introduced the STOXX ESG Impact Indices, which track companies with the greatest exposure to selected ESG key performance indicators (KPIs) that have been shown to lower single-stock volatility, helping long-term returns.
“The traditional ESG approaches so far have largely been agnostic to the portfolio’s return and risk characteristics,” says Jones. “The STOXX ESG Impact indices change that.”
“The development curve for identifying and using KPIs in ESG applications is in its early days, and this is very promising,” adds Thomas. “It is now possible for asset managers to develop and apply systematic strategies that evaluate a company’s risk and opportunities by examining its ESG indicators.”
In the STOXX ESG Impact Indices’ case, the KPIs are standardized by industry. Additionally, the index composition is weighted by free-float market capitalization, while country weightings are capped.
These steps are important to minimize concentration risk, according to Thomas. This means the indices can provide outperformance and sustainability, but also low tracking error to their respective market benchmarks.
Outlook for growth
The pace of adoption of responsible investing practices looks far from slowing down, according to Thomas.
“A growing number of companies are reporting sustainability metrics together with their financial statements,” he says. “The investment community will welcome the combination of sustainability principles and the traditional focus on risk-adjusted returns.”
Jones agrees with the outlook for growth. STOXX has partnered with leading data providers for its ESG index solutions, including Sustainalytics, CDP Europe and ISS ESG and will continue to embrace innovation in responsible investing products.
“Responsible investing has become a new minimum requirement for many asset owners,” he says. “STOXX will support this positive trend by setting the standards in the ESG indexing space with innovative, tradable and global sustainability indices.”
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