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Earth Day 2017: The rise of smart sustainability

By: Tony Campos, Director, ESG Product Management

Earth Day 2017 is a good time to examine the rapidly growing influence of environmental, social and governance (ESG) concerns on the global economy as investors and asset owners move more actively to integrate ESG practices into their models.

Increasingly, investors are treating ESG as an economic, as well as an ethical, imperative; and they are putting their money where their mouths are. For instance, CalPERS, CalSTRS and KWAP are examples of institutional investors implementing sustainable investing models and ESG allocations. At the same time, with the deployment of more advanced tools, the investment industry’s approach to ESG continues to grow in sophistication.

We see this as a key development in ESG investing, which we’re calling “Smart Sustainability.”

Smart Sustainability is the application of ESG considerations to a smart beta index construction, thus combining the two rising investment trends of smart beta index adoption and ESG investing. This concept of a Smart Sustainability index provides index users with tools to assist them in implementing their sustainable investment strategies with more sophistication than they did in the past. Previously, when asset owners incorporated ESG considerations in their portfolio selection, they primarily focused on exclusionary tactics such as screening. They would, for example, design a portfolio “ex-tobacco companies” or “ex-carbon companies.” Today, the approach is inclusive, not exclusive. Asset owners are now using ESG data in a similar way to factor data.

By incorporating ESG considerations with smart beta index methodology, participants can now treat ESG factors in a Smart Sustainability index market as they would treat any other traditional factor tilt such as value or growth. In the past, as part of a sustainable investment strategy, market participants might use the Russell 1000® Index, for example, for asset allocation purposes and exclude certain companies entirely. Today, that same market participant can use a smart sustainability index constructed from the Russell 1000® Index with a tilt toward climate-friendly companies, for example.

This new Smart Sustainability approach is being implemented by a growing number of large global asset owners. Previously confined primarily to stock analysis, ESG data is now an integral part of many overall portfolio management strategies.

In fact, according to the upcoming FTSE Russell Global Asset Owner Survey, to be released in mid-May, interest in Smart Sustainability strategies is growing significantly among the largest asset owners globally. These strategies are being considered and implemented for fundamental investment reasons such as risk reduction and return enhancement rather than “green” or “sustainable” investing for its own sake. Look for more specific findings on this topic when we release the full survey next month.

To illustrate, the CIO of HSBC Bank UK Pension Scheme recently described to FTSE Russell how his trustees see climate change as a systemic risk, affecting all of the companies in its portfolio. Climate change is therefore seen as relevant to benchmark design alongside more traditional smart beta factors such as volatility, size, quality and value. Working alongside HSBC and Legal & General Investment Management, FTSE Russell helped develop the index underlying a multi-factor global equities index fund that incorporates the investment risks associated with climate change and risk premia factors.

With companies providing a higher quality of ESG disclosure, investors are able to make more informed decisions about their ESG exposure than before. Combined with the increasing sophistication of analytical tools and methodologies, such as smart beta indexes, the move towards Smart Sustainability seems likely to continue to gain momentum.

To learn more about ESG reporting, further information on our sustainability framework can be found at FTSE Russell ESG Spotlight.

 

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