What do investors look for when buying an Environmental, Social and Governance (ESG) equity index fund? In principle, similar to other fund investment decisions, higher financial returns, greater portfolio diversification. , and low volatility.
But whatever investors want from an ESG fund, they may expect it to outperform other funds on ESG criteria. After all, why would he call a fund ‘ESG’ if it doesn’t consider ESG factors in its investment decisions?
The problem is not just academic. ESG funds, including both mutual funds and exchange-traded funds (ETFs), $400 billion market only in the US.
The first step in testing whether an ESG fund offers higher ESG scores is deciding what to compare against.
Many ESG funds track ESG indices, often provided by third-party indexers such as MSCI and S&P. For example, the SPDR S&P 500 ESG ETF is managed by State Street, has $715 million in assets under management (AUM) and is listed under the ticker EFIV. According to the latest publicly available information, EFIV “aims to provide investment results that broadly correspond to the S&P 500 ESG Index, net of fees and expenses.” fact sheet.
The S&P 500 ESG Index itself is “a broad market capitalization-weighted index designed to measure the performance of securities that meet sustainability criteria while maintaining similar overall industry group weightings to the S&P 500. is” fact sheet From S&P Global.
Of course, the S&P 500 is a standard market capitalization weighted stock market index and serves as a benchmark for many index funds.
The S&P 500 ESG Index Fact Sheet refers to the S&P 500 as the “benchmark” and compares its price performance to the S&P 500. Eight of the top 10 stocks in the S&P 500 ESG Index are also included in the top 10 stocks of the S&P 500. In fact, the same four companies (Apple, Microsoft, Amazon, and NVIDIA) are listed in the same order as their top four holdings.
The SPDR S&P 500 ESG ETF tracks an ESG index that itself tracks a market index, so you should pay attention to whether the ESG index has a higher ESG score than the benchmark S&P 500. Ultimately, the ESG designation is the main difference between the two indices. Nevertheless, the factsheet did not include his ESG scores for these funds.
Therefore, to approximate the ESG score, we took each of the top 10 stocks and manually calculated a cap-weighted score using each company’s publicly available ESG ratings from MSCI and Sustainalytics.
After averaging the two rating agency results, we found that the S&P 500 ESG Index has a 6.0% higher cap-weighted ESG score than the S&P 500.
ESG Scores: ESG Indices and Market Indices
We repeated this exercise with 19 other popular ESG indices. In each case, we verified that the ESG index compared its performance to mainstream market indices and calculated his ESG “uplift” to the benchmark based on the top 10 stocks in each index.
Admittedly, the top 10 holdings are no imperfect proxy for the overall index, but the companies in question account for an average of 25% and 31% of total market capitalization in market and ESG indices, respectively. Additionally, an ESG index creator will want to select the companies with the highest ESG ratings for his largest holdings, unless there is a significant tracking error compared to the benchmark. Such a selection process further facilitates the apparent improvement of her ESG criteria in his ESG index over mainstream market benchmarks.
ESG Indices ESG Score Improvements and Market Indices Comparison
However, our key finding is that ESG indices typically have only slightly higher ESG scores than their parent market indices. Some ESG indices have lower cap-weighted scores than their parent indices, resulting in even lower ESG values.
The volatility between the ESG index and the market volatility ranged widely from -26% to +43%, but most deltas fell between 0 and 10% with an overall average of 8.3%.
Whether a small improvement in ESG scores is significant is a question for each fund’s investors. But if the investor does not have this information, the question cannot be answered.
Investor Pay 40% higher fees Sustainable funds are higher on average than non-ESG funds. However, according to our research, investors should think again if they think higher fees will buy him a much higher ESG score.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect those of CFA Institute or the author’s employer.
Image credit: ©Getty Images / george tsartsianidis
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