Scientific Beta takes aim at MSCI’s stance on controversial weapons

Feb 21st, 2019 | By | Category: ETF and Index News

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Smart beta index provider Scientific Beta has published an open letter to MSCI in which it criticizes the firm’s stance against the exclusion of controversial weapons from global cap-weighted indices.

Professor Noël Amenc, CEO of Scientific Beta

Professor Noël Amenc, CEO of Scientific Beta.

The letter, penned by Professor Noël Amenc, CEO of Scientific Beta, was written in reference to Swiss Sustainable Finance’s open letter, dated 31 January 2019.

This letter called on index providers to remove companies involved in controversial weapons from their mainstream indices.

It highlighted a number of international conventions which prohibit or restrict the development, production, and use of controversial weapons, and noted that some countries have gone further by implementing legislation against the financing of such weapons.

As such, many institutional investors consider as standard practice the avoidance of investing in controversial weapons firms.

However, Swiss Sustainable Finance noted that with mainstream indices continuing to include such companies, some active and passive investors may be unable to invest in controversial weapons-free solutions.

As of 31 January 2019, the letter had collected 141 signatories representing $6.8 trillion in assets under management.

In response to Swiss Sustainable Finance’s open letter, MSCI argued that for a broad cap-weighted index to represent all investment opportunities within its segment, it cannot contain an ESG filter by default.

However, Amenc believes that this argument is not admissible: “From a practical point of view, we know that the exclusions on controversial weapons proposed by Swiss Sustainable Finance represent a very marginal weight that in any event is far lower than the exclusions or weight limitations implemented by all index providers to guarantee the liquidity and investability of their global cap-weighted indices.”

Amenc also asserts that the argument that the cap-weighted index is the representation of the theoretical true market portfolio has no scientific credibility.

He writes, “We know that the cap-weighted index is ultimately an index like any other that has the particular virtue of providing the weighted average performance of the market. Excluding stocks that represent controversial weapons would not affect this average significantly.”

Scientific Beta was also critical of MSCI’s provision of an optional controversial weapons-free benchmark that is accessible to clients through a paid service, noting that this falls short of what is at stake from an ethical standpoint.

Amenc writes, “MSCI’s response is representative of the attitude of a large share of the players in the index industry who consider that ESG is a good business opportunity rather than an opportunity to do good. Index providers too often perceive ESG as a driver of profits by increasing the number of costly options for access to data.”

Scientific Beta has committed from June 2019 to offering all its clients an ESG option on its smart beta index series at no additional cost.

This ESG-screening will provide for a minimal exclusion representing fewer than 5% of the stocks in the global universe.

Apart from the removal of controversial weapons, this exclusion will also take into account tobacco, the coal industry and coal-based resources, companies that openly violate ethical standards, and companies that do not guarantee equal voting rights to shareholders without compensation.

Scientific Beta will also undertake a consultation of its clients that aims to consider these exclusions as the default choice (with an opt-out approach) and no longer as an opt-in option to be exercised by the investor, as proposed by other index providers.

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