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Providing investors with the option to exclude controversial weapons from their benchmarks

A 2007 documentary in The Netherlands uncovered evidence that many pension funds were invested in companies that manufactured certain controversial weapons, such as chemical weapons, land mines and cluster munitions. This led to significant public disquiet, which in turn led to changes in the investment industry. And for many years a number of predominantly European investment institutions have avoided investing in these types of firms. In addition, there is a legal basis for investors to avoid controversial weapons as a number of these are subject to international treaties that ban or limit their use by law: many countries have legislated against the direct and/or indirect financing of controversial weapons manufacturers[1].

While there are actually only a very small number of listed companies involved in the manufacture of controversial weapons, it has become increasingly common among asset owners to exclude these companies from their portfolios. This approach is now often applied by larger pension fund portfolios across northern Europe and is available to smaller investors through pooled funds. The Vanguard Global and European SRI funds are examples of funds which begin with very broad diversified indexes from FTSE Russell, but then remove a small number of companies on the basis of this type of screen as well as on the basis of extreme controversies. In another recent example, these exclusions were applied to the FTSE All-World ex CW Climate Balanced Factor Index, used for Legal and General’s Future World Fund and as the basis for HSBC’s UK pensions defined contribution default equity fund.

FTSE Russell has been providing clients with index options to help clients exclude such companies from their benchmarks for many years. For example, our flagship FTSE4Good Index Series automatically excludes companies operating in this sector and the demand appears to be gaining further momentum. A global coalition of investors has issued an open letter calling on index providers to remove all companies involved with controversial weapons from mainstream benchmarks. This initiative was launched by Swiss investors and has thus far been backed by both domestic and international asset owners and managers with total assets in excess of $3.5 trillion. The letter highlights controversial weapons exclusion as an integral part of the broader global trend to invest responsibly.

We believe it is important to provide investors with tools to exclude controversial weapons from their portfolios, should they wish as we have been doing for many years. To further this agenda, we are in the process of creating separate versions of our broad indexes that will exclude companies involved with controversial weapons, which will be introduced in 2019. By creating mainstream indices that exclude controversial weapons, we are continuing to offer choice to our clients, responding to the position that this becoming standard practice among investors.

It is important to recognize that investors have different ways of defining controversial weapons. For example, some investors include nuclear weapons in their definition of controversial weapons, whilst others might make a distinction based on the client countries for the weapons. As always, we will seek to address broad investor consensus on this issue while providing other options for those investors who take a different view.

We also observe that there is growing investor focus on excluding other contentious business activities such as tobacco that may not be aligned with their sustainable investment beliefs and objectives. How investors define the boundaries of their investable universe will vary; for some it is only about investability and liquidity, while for others additional and differing considerations apply. To this point, we expect to further expand our Global Choice Index Series to continue to grow the range of choices available to investors. This will enable investors to align their benchmarks with their specific investment duties, beliefs and needs.

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[1] Swiss Sustainable Finance, “Focus: Controversial weapons exclusions”, 2017 

 

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