Earlier this year, S&P also launched the S&P 500 ESG Index Series—offering a sustainable alternative to the world’s largest and most widely used benchmark. As Naqvi explains, investors in the early socially responsible investment (SRI) movement tended to focus on divesting from sin stocks and thus had to accept a much higher level of risk because of a lack of portfolio diversification. But advances in the quality and availability of ESG data means broad market indices can now be reweighted to enhance ESG performance, with low levels of tracking error and thus without having to sacrifice very much (if anything at all) in terms of investment returns. Thus enabling mainstream investors to align their investments with their values without compromising their investment objectives. “So this dispels the myth that ESG investing implies a tradeoff with financial returns,” says Naqvi, “and I think that’s very appealing for mainstream investors.”
The S&P 500 ESG Index was constructed to provide a similar risk/return profile to the S&P 500 Index and to avoid companies that are not managing their businesses in line with ESG principles, while including companies that are. The underlying S&P DJI ESG Scores have been calculated by SAM, part of RobecoSAM, with whom S&P Dow Jones Indices has had a 20-year partnership starting with the launch of the Dow Jones Sustainability Index, the first global sustainability benchmark. Naqvi describes the research process RobecoSAM has drawn upon to manage its assets for decades: “By drawing upon real life investment performance data over the past 20 years, they’re able to identify the most financially material and relevant ESG signals within specific industries, rather than simply taking a theoretical or academic approach to ESG as you typically find with other data sets. This offers us a powerful dataset for our data clients and for the construction of our ESG indices.”
The Index first excludes companies involved in the production of tobacco, controversial weapons, or those with low UN Global Compact scores. It also excludes the bottom 25% of ESG ranked companies globally within industry groups. The methodology then selects the top 75% of market cap within each industry group of the S&P 500, ranked by the new S&P DJI ESG Scores. “It turns out,” says Naqvi, “that by targeting the best ESG-ranked companies within industries, you still end up closely tracking performance of the S&P 500.”
The Future
Naqvi believes we’re at a fascinating juncture in the ESG space. The amount of data on the sustainability performance of companies continues to grow as public reporting improves, and leading datasets like S&P DJI ESG Scores (calculated by SAM) are helping to fill the gaps. “This is enabling index providers like us to create much more innovative and nuanced ESG benchmarking solutions,” says Naqvi, “and that is in turn rapidly fueling a whole host of index linked products in the market that are attractive for mainstream investors.”
Naqvi gave a few examples of the ESG products S&P Dow Jones Indices is offering to the market. These include best in class approaches with broad sector exclusions, more inclusive broad market benchmarks with ESG enhancements, and a whole range of products in between. In addition to the recently launched S&P 500 ESG Index, Naqvi’s team recently launched ESG versions of 23 other regional and country-specific headline benchmarks based on the same methodology. “We also continue to lead on climate aligned strategies with our low carbon, fossil fuel free, and our more forward looking and sophisticated methodologies, like our carbon price risk-adjusted index series that we launched using Trucost data,” says Naqvi. “Over the coming years we plan to launch a whole host of ESG products to give investors choice in aligning their values with their investment strategies, whatever they may be.”
Paul Ellis founded Paul Ellis Consulting to work with financial advisors who want to integrate sustainable and impact investment strategies for their clients.