Julia Kochetygova, Head of Sustainability Indices at S&P Dow Jones Indices (S&P DJI), a leading index provider to the exchange-traded fund industry, has compiled a note reflecting on the growing prominence of environmental, social and governance (ESG) investment themes during 2015. Over the course of the year, the ETF industry has kept up with the times as evidenced through increased launches of funds tailored towards the ESG conscious investor.
Institutional investors have shown a clear desire to adopt investments with strong ESG characteristics including a significant shift towards renewable energy sources.
According to S&P DJI, one of the major themes in the investment sphere in 2015 has been a broadening of investment objectives to include goals such as positive ‘impact investing’ and the sustainability of ‘natural capital’. As such, there has been a significant shift away from companies operating in non-renewable resource industries (the most noteworthy movements have been away from coal power generation) and from those with poor ESG track records.
The note highlights the Mercer European Study 2015 which found that 36% of institutional investors do not consider ESG risk factors when making investment decisions; this is down from 48% reported in 2014.
Within the ETF industry itself, a report from index provider MSCI in September 2015 revealed that ETFs assets tracking its ESG equity indices had increased by 140% from December 2013 to end of August 2015.
According to S&P DJI’s Kochetygova, climate change has been a dominant issue within the ESG framework and investment managers have shown a great desire to address this. She notes, for example, the Montreal Carbon Pledge, whereby members must disclose the carbon footprint of their portfolios, has topped $10tn in registered assets; and the Portfolio Decarbonization Coalition, whereby members actively decarbonize their portfolios has surpassed $600bn. And, more recently, the United Nations Climate Change Conference resulted in an agreement between the 195 participants to set a goal of limiting global warming to less than 2 degrees Celsius compared to pre-industrial levels.
The change in sentiment towards coal power generation industries, a decline in the profitability of oil industries due to a prolonged depression of crude prices, and the falling costs in the renewable energy sector have created a drive in demand for green initiative investing. Issuance of green bonds, those which raise finance for environmentally sustainable investments, have grown recently to $41bn as of early December. Furthermore, the Paris Greens Bond Statement is an understanding, signed by 27 global investors representing over $11.2tn in assets, to fully support policies that drive the development of a global market in green bonds.
From a financial point of view, long-term portfolio risk/return characteristics may be enhanced through integrating an ESG framework to investment decisions. This occurs through a reduction in litigation and reputational risk. RebecoSAM, an investment specialist focusing exclusively on sustainability investing, published their Smart ESG Integration whitepaper in September. The report was able to show through a quantitative analysis of various ESG-focused indices that alpha is repeatedly captured in these indices compared to broad equity benchmarks.
Some of the developments during 2015 in the indexing and ETF industry relevant to the ESG space include among others:
– Vigeo and Euronext launched the Euronext-Vigeo EM 70 Index, a compilation of the 70 highest ESG-ranked companies within the Russell Emerging Markets Index.
– Euronext sharpened the methodology behind its Low Carbon 100 Europe Index, including firms’ positive contributions to the transitional process to carbon emission reduction, rather than solely at emission levels.
– State Street Global Advisors launched the SPDR S&P 500 Fossil Fuel Free ETF (SPYX) on the NYSE Arca, providing a broadly similar exposure to the S&P 500 Index but only includes firms that do not own fossil fuel reserves. At the time of launch, the index contained 475 securities.
– Etho Capital, a US-based sustainable investment manager, launched the ETHO ETF (ETHO), a broad-based, diversified, socially responsible and fossil fuel-free equity RTF with no exposure to the energy sector.
– S&P Dow Jones launched the Dow Jones Sustainability Europe Diversified High Beta High Dividend Index, measuring the performance of high yielding stocks with high historical betas constructed from an eligible universe of companies with high ESG scores. S&P DJI also unveiled a suite of carbon efficient indices.
– Goldman Sachs filed with the SEC to launch an ESG-compliant S&P 500 ETF