Judging from the proliferation of new indexes over the last decade, it seems almost certain that wherever there is a hot investment trend, an index is sure to follow. So it goes with sustainable investing, a relatively new concept that seeks to connect the dots between good corporate behavior and superior stock performance.
Corporate sustainability analysts believe the environmental, social and governance (ESG) behavior of a company can determine whether it is likely to survive and thrive over the long term. Proponents of this approach say they can uncover better-managed companies by focusing on features such as good environmental track records, diverse managements or boards, transparent financial reporting and prudent lending practices, as well as by filtering out companies who are weak in these areas in ways that could come back to bite investors.
Sustainable investing differs from its better-known cousin, socially responsible investing, in a number of ways. It does not involve screening out so-called "sin stocks," such as those companies manufacturing tobacco, alcohol or weaponry. It takes no position on religion, abortion or vice. Instead, it shifts the focus from values to more hard-nosed financial considerations such as corporate financial reporting, risk management techniques and environmental responsibility.
Proponents see sustainable investing as more encompassing than SRI, with a greater potential to grow into a mainstream investment philosophy. "Over the next 15 years, I think there will be a transition from the old world of socially responsible investing to the new world of sustainable investing," says Joseph Keefe, president and CEO of Pax World Management, which has a family of SRI mutual funds. Keefe says the discipline points investors in the direction of better-managed companies and that there is overwhelming evidence that environmental, social and governance factors make for better investing.
A Growing Product Roster
A number of sustainability indexes, and products based on them, promise to bring sustainable investing to the masses. Dow Jones' series of sustainability indexes (DJSI) have been around since 1999 covering both U.S. and foreign markets. In the U.S., the Dreyfus Corporation licenses one of these indexes for its Dreyfus Global Sustainability Fund, and State Street Global Advisors uses another for separate accounts. In late April, TD Asset Management launched the TDAM Global Sustainability Fund, which draws its investments from the Dow Jones Sustainability World Index.
A Dow Jones spokesperson says several other U.S. funds have registered with the SEC as well for new portfolios based on these indexes.
Other funds are tapping sustainability indexes forged by KLD Research & Analytics in partnership with U.K.-based FTSE International in a co-branding deal begun in May 2009. KLD's three sustainability indexes include the FTSE KLD Global Sustainability Index, the FTSE KLD North America Sustainability Index and the FTSE KLD Europe Asia Pacific Sustainability Index.
KLD's global index forms the basis for a fund launched by Northern Trust and variable annuities from TIAA-CREF. Pax World also plans to introduce a suite of investment products based on the FTSE KLD indexes, including ETFs, mutual funds and separately managed accounts, though no launch date has been set.
In addition to its co-branded KLD products, FTSE also has the FTSE Environmental Markets index series and the FTSE4Good. The latter is used by Vanguard's FTSE Social Index Fund.
Meanwhile, Dimensional Fund Advisors, a major provider of enhanced index funds, draws from an eligible investment universe provided mainly by a company called Sustainable Holdings for its U.S. Sustainability Core 1 Portfolio and the International Sustainability Core 1 Portfolio.
Companies that license such indexes use them in different ways. Northern Trust simply replicates the FTSE KLD index in its mutual fund. TIAA-CREF customizes the portfolio by adding a layer of financial screens. The Dreyfus Global Sustainability Fund also uses financial screens and may include companies not in the Dow Jones index according to its own sustainability criteria.