ESG indexes were the main growth drivers in indexing in 2020 with a 40.2% increase, according to the fourth annual global benchmark survey of the Index Industry Association (IIA). This was the highest year-on-year increase in any single major index class in the survey’s four-year history. The growing demand for ESG products and for measurement tools that accurately depict sustainable investment objectives underpin this trend.
What is an ESG index? An index is a group of securities designed to represent a particular market. ESG indexes differ from traditional broad market indexes in that they incorporae ESG criteria into the security selection. Other than that, they are subject to the same policies and procedures.
ESG indexes are designed to help investors benchmark the ESG performance of assets. The largest index providers include MSCI, FTSE Russell, Bloomberg, S&P Dow Jones and Thomson Reuters. Note that several rating providers are also index providers.
Why are these indexes important? Besides being performance benchmarks, several investment firms offer mutual funds and ETFs that track ESG indexes to build their portfolios. ESG ETFs are the main drivers of sustainable investing. In addition, these indexes also serve as a benchmark for asset allocation in wealth management. Thus, you need to have a basic understanding of ESG indexes to get a grasp of how fund managers build their portfolios.
Just like ESG ratings, ESG indexes should be interpreted with caution. Why? Mainly due to uncertainties concerning their providers' ability to assess underlying data properly. There is increasing pressure on providers to be transparent about those underlying factors. Another problem is that ESG indexes often show conflicting ESG rankings. When in doubt, you should ask your asset manager why they chose the index they follow.
Let’s have a look at some of the main ESG index providers
MSCI ESG RESEARCH
MSCI provides more than 1,500 equity and fixed income ESG indexes. The indexes are grouped into three categories: integration, values and screen and impact.
- The FTSE ESG Indexes provide risk/return characteristics similar to the underlying universe with the added benefit of improved index level ESG performance.
- FTSE ESG Low Carbon Emissions Target Exposure Indexes target a reduction in index level carbon emissions and improvement in the aggregate ESG Rating.
- Refinitiv/S-Network ESG best practice indices are designed to provide a benchmark of companies exhibiting best corporate social responsibility practices. Over 7,000 companies worldwide are rated in over 400 key indicators of ESG performance.
- Thomson Reuters/Future Super Australia fossil free index has a strict exclusion policy for companies directly or indirectly involved in fossil fuels and those that provide financing to the fossil fuel sector.
- Thomson Reuters Global Resource Protection Select Index captures the performance of stocks that tend to reduce the use of materials, energy or water by applying more eco-efficient solutions and improving supply chain management.
- Refinitiv Eurozone ESG Select Index captures the performance of the shares of European companies in selected countries that actively invest in and ESG values and principles in their operations.
Bloomberg partners with external ESG ratings, framework and data providers to create index alternatives.
- Bloomberg SASB ESG Indices are created in collaboration with the Sustainability Accounting Standards Board (SASB). The index family focuses on the subset of ESG factors most likely to materially impact the financial condition or operating performance of companies in a given industry.
- Bloomberg Barclays MSCI ESG Indices are produced in partnership with MSCI ESG Research. The core ESG fixed income family includes indices focused on three different ESG methodologies: Socially Responsible (SRI), Sustainable and ESG-weighted. In addition, they offer a family of Green Bond indices for climate-focused and impact investors.
S&P DOW JONES
The company offers core ESG, climate and thematic ESG indices. The recently introduced S&P Sustainability Screened Indices, the S&P 500®, S&P MidCap 400®, S&P SmallCap 600®, screen out companies with involvement in controversial business activities, regardless of how the screening might impact sector or industry composition.