HSBC Global Asset Management has further extended its sustainable ETF line-up with the launch of a UK exposure on the London Stock Exchange.

HSBC GAM has rolled out its seventh ESG low carbon equity ETF.

Representing the seventh fund in the range, the HSBC UK Sustainable Equity UCITS ETF (HSUK LN) provides access to a portfolio of UK equities that have been adjudged to exhibit a low carbon footprint and a favourable environmental, social and governance profile.

The fund does this by tracking the FTSE UK ESG Low Carbon Select Index, an index developed in partnership with FTSE Russell and derived from its FTSE UK Index stock universe (for all intents and purposes the FTSE 100 plus a few stocks from the FTSE 250).

Methodology

The index methodology deploys a series of exclusionary screens and a modified, triple-tilted weighting scheme to calibrate exposure to meet the fund’s objectives.

The index construction process first removes companies that have been identified as being involved in various controversial industries. This includes companies involved in the manufacture of weapons and tobacco products, companies involved in the extraction or use of thermal coal, and companies involved in electricity generation from nuclear power.

Companies considered to be in breach of any of the UN Global Compact principles, which cover human rights, labour, environment and anticorruption, are also rejected.

The reduction in exposure to carbon is tackled in the weighting stage; ESG enhancement is also achieved at this point.

Essentially, an optimization algorithm processes information relating to each eligible company’s ESG rating (as measured by FTSE Russell) and operational carbon emissions and fossil fuel reserves (based on third-party data) to weight constituents so as to manipulate both a 50% reduction in carbon emissions and fossil fuel reserve intensity and a 20% uplift in ESG rating, all relative to the parent universe, subject to country, industry, maximum stock capacity, maximum company weight, and minimum diversification constraints.

Diversification implications

The net result is an index that contains fewer constituents than the parent index (64 vs. 119) but displays a more attractive ESG profile and a lower carbon footprint. However, this comes at a noticeable cost in terms of reduced diversification and tracking difference.

A cursory glance over the index shows that investors will be taking on some sizeable active positions. For example, the largest constituent in the index is Unilever with a weight of 10.5%. This compares to just 3.4% for the FTSE UK Index. Similarly, the index has a 7.2% weight in Aviva versus a mere 0.7% for the FTSE UK. Plus there’s a 5.1% weight in Mondi versus 0.5% for FTSE UK, and, interestingly for ethically conscious investors, a 6.1% weight in HSBC itself – 50% more than its weight in the FTSE UK and this is after the so-called FinCEN files suggested that HSBC had allowed criminals to launder millions of dollars of dirty cash! For traditional passive investors, these are all hefty active bets. Indeed, more than two-thirds (67.6%) of the index is allocated to just 10 companies which in the FTSE UK constitute only 20.9%. (Data as of 30 September 2020).

This highlights a potential fragility of highly engineered “ESG plus” strategies. They are likely to work reasonably well with only modest diversification implications in markets where the universe of securities is large, e.g. World, US, Europe etc. But when the pool of eligible securities becomes too small, as could be the case with some single-country universes, the resultant portfolio may exhibit a number of concentrated and potentially questionable positions.

‘Sustainable future’

Nevertheless, for investors resolutely committed to investing sustainably, the fund represents a useful and highly innovative addition to their toolkit. And besides, there are credible arguments that most of the benefits of diversification can be achieved with a portfolio holding as few as 20 securities.

Commenting on the launch, Olga De Tapia, Global Head of ETF Sales at HSBC Global Asset Management, said: “We’re pleased to offer our clients the first UK sustainable equity ETF with a reduced carbon target. As the latest addition to our sustainable equity ETF range, it will enable investors to tap into UK companies that are transitioning to a more sustainable future.”

The ETF trades in GBP and comes with a total expense ratio of just 0.12%.

It joins other products in the range, namely:

HSBC Europe Sustainable Equity UCITS ETF
HSBC Japan Sustainable Equity UCITS ETF
HSBC USA Sustainable Equity UCITS ETF
HSBC Developed World Sustainable Equity UCITS ETF
HSBC Asia Pacific ex Japan Sustainable Equity UCITS ETF
HSBC Emerging Market Sustainable Equity UCITS ETF