By: Tony Campos, director, ESG product management
Sustainable investing is becoming the new normal as global market participants are increasingly looking to incorporate ESG investment approaches into their investment philosophy and strategies. This growing demand for ESG integration has helped inform investor’s stewardship initiatives, in particular how companies and investors interact in the new global economy. (Stewardship refers to the responsibility companies have to understand their impact on the environment and society.)
Due to the increased concerns surrounding issues such as climate change, diversity, voting rights, social unrest and economic vitality, corporate leaders are changing their operational models for long-term value creation. As the stewardship trend grows in popularity, market participants around the world are proactively taking steps to align stewardship and investment activities in a way that integrates ESG considerations. Results from this year’s FTSE Russell survey, Smart beta: 2017 global survey findings from asset owners, detail the strong interest in applying ESG considerations to smart beta, or as FTSE Russell has referred to it, "Smart Sustainability."
In both North America and Europe, interest in smart sustainability index-based strategies is strongest among the largest asset owners with AUM greater than $10 billion, yet regional differences persist. Within this size tier, nearly 80% of asset owners domiciled in Europe anticipate applying ESG considerations to a smart beta strategy while 30% of asset owners domiciled in North America do. The survey further highlights that the primary motivations of the asset owners to use a smart sustainability index-based strategy are investment decision that is led—rather than driven—by regulatory requirements or social goals.
In some regions, that interest has already turned into action. Earlier this year in the UK, HSBC Bank UK Pension Scheme selected Legal & General Investment Management (LGIM) Future World Fund for the £1.85 billion equity default option in its DC scheme. HSBC sought to change its default equity pension fund with LGIM to a sustainable investment model with improved risk-adjusted returns for the pension members.
FTSE Russell took account of HSBC’s indexing requirements and created the award-winning FTSE All-World ex CW Climate Balanced Factor Index. The rules underlying this index are applied to capture and combine broad, comprehensive market exposure with factor-based smart beta while making adjustments for climate change such as reducing exposure to fossil fuels and greenhouse gases in addition to increasing exposure to the revenues from green products.
A key example of this trend can also be found in Japan, where market participants are increasingly looking to incorporate sustainable investment approaches into their investment philosophy and stewardship strategies. The introduction of the Japanese Stewardship Code has acted as a catalyst to promote responsible ownership of investee companies by Japanese institutional investors. The Code was introduced in 2014 by the Financial Services Agency in order to "promote sustainable growth of companies through investment and dialogue." This further validates the notion that ESG and Stewardship have an important role to play in the effective management of, and interaction within, capital markets in Japan.
To help investors and other market participants integrate and promote ESG considerations, FTSE Russell designed the FTSE Blossom Japan Index. The index only includes companies that exhibit effective management of ESG-related risks and closely tracks the industry weights of the broad-based market index.
Interestingly, when comparing all large and mid-capitalization companies in Developed markets, as represented by the FTSE Developed Index, the Japanese market’s average ESG Scores are lower than the average of all developed markets ex-Japan in 10 of the 14 Themes in FTSE Russell’s ESG Ratings, based on June 2017 data. As shown in the chart, the four Themes where Japanese companies have a higher average Score are part of the Environmental Pillar: Water Use, Supply Chain – Environmental, Pollution & Resources and Biodiversity.
Using the FTSE Blossom Japan Index as the Japanese market comparison changes the picture substantially. The average ESG Scores in the FTSE Blossom Japan Index are higher than the average of all developed markets ex-Japan in the 10 Environmental and Social Themes. The average scores in the FTSE Blossom Japan Index are lower than the developed market ex-Japan average, but are higher than the FTSE Japan Index average in all four of the Governance Themes.
The alignment of stewardship efforts, particularly engagement strategies, with investment activities creates consistent and strong incentives for change. With the increasing sophistication of analytical tools and methodologies, such as smart beta indexes, the move towards ESG integration seems likely to continue to gain momentum globally.
To learn more about ESG integration into indexes, further information on our sustainability framework can be found at ESG spotlight.
 FTSE Russell were joint winners with LGIM in 2017 of the 18th annual Pension and Investment Provider Awards which recognises excellence among providers of products and services to UK workplace pension schemes. The three key criteria used to adjudicate the awards are performance, innovation and service standards
© 2017 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE TMX Global Debt Capital Markets Inc. and FTSE TMX Global Debt Capital Markets Limited (together, “FTSE TMX”) and (4) MTSNext Limited (“MTSNext”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE TMX and MTS Next Limited. “FTSE®”, “Russell®”, “FTSE Russell®” “MTS®”, “FTSE TMX®”, “FTSE4Good®” and “ICB®” and all other trademarks and service marks used herein (whether registered or unregistered) are trade marks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, or FTSE TMX.
All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for any errors or for any loss from use of this publication or any of the information or data contained herein.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell indexes or the fitness or suitability of the indexes for any particular purpose to which they might be put.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group index data and the use of their data to create financial products require a licence from FTSE, Russell, FTSE TMX, MTSNext and/or their respective licensors.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.