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
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