By Mark Barnes, PhD, head of investment research (Americas)
Investors are increasingly looking for straightforward ways to align their investments with their personal views on environmental and societal issues. Our analysis, as examined in our paper on this topic, shows that combining ESG screens with a transparent, rules-based index construction methodology results in indexes that are close substitutes for the underlying indexes with which investors are most familiar.
This blog is the latest in a series of research articles focused on global sustainable-investing strategies. Our research paper presents six-year case studies for the FTSE Australia 300 Choice and FTSE Developed ex Australia Choice indexes, two market-capitalization-weighted indexes employing a rules-based methodology that enables investors to apply robust ESG-values-based exclusion directives to a broad market index.
While the Global Choice screening process can have a significant impact on the composition of certain industries, our research found that the overall long-term effect on index performance was minimal, and that Global Choice indexes behaved very similarly to their underlying benchmarks (with correlations and betas close to 1 over time). These findings offer investors the confidence that these indexes can serve as close substitutes for their underlying benchmarks while allowing them to express their ESG principles in portfolios.
For illustrative purposes, we present the performance statistics for the FTSE Australia 300 Choice Index, which uses the FTSE Australia 300 benchmark as the starting universe, for the six-year period ended March 31, 2021. As shown, Australia 300 Choice lagged the underlying benchmark’s annualized gain of roughly 6.75% by a modest 10 basis points, with comparable volatility. The tracking error over this period was 2.45%.
Performance statistics – April 2015 to March 2021 (AUD)
Source: FTSE Russell. Data based on monthly returns from April 1, 2015, through March 31, 2021. Past performance is no guarantee of future results. Please see end for important legal disclosures.
To get a better sense of the stability of co-movement, we also calculated correlations over a rolling two-year period. As shown below, though the correlation briefly dipped below 0.95 earlier in the period it has stabilized around a high of approximately 0.994 more recently. Our research revealed similar results for the FTSE Developed ex Australia Choice Index, which outperformed its cap-weighted benchmark by approximately 98 basis points annually.
Correlation – FTSE Australia 300 Choice Index relative to FTSE Australia 300 benchmark (24-month-rolling window)
Source: FTSE Russell. Data through March 31, 2021. Past performance is no guarantee of future results. Please see end for important legal disclosures.
The chart below plots the annualized volatility of the Australia 300 Choice index and the underlying benchmark over a 24-month window. As shown, the characteristics of the two indexes are similar enough that the volatility of the Australia 300 Choice index has tightly matched that of the benchmark over time. Again, this indicates that the Australia 300 Choice index is a close substitute for the underlying benchmark.
Annualized volatility – FTSE Australia 300 Choice Index and FTSE Australia 300 benchmark (24-month-rolling window)
Source: FTSE Russell. Data through March 31, 2021. Past performance is no guarantee of future results. Please see end for important legal disclosures.
© 2022 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 Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) FTSE Fixed Income Europe Limited (“FTSE FI Europe”), (5) FTSE Fixed Income LLC (“FTSE FI”), (6) The Yield Book Inc (“YB”) and (7) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “FTSE4Good®”, “ICB®”, “The Yield Book®”, “Beyond Ratings®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks 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, FTSE Canada, FTSE FI, FTSE FI Europe, YB or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided "as is" without warranty of any kind. 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 accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell products, including but not limited to indexes, data and analytics, or the fitness or suitability of the FTSE Russell products for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell products is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this document 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 or whether such investment creates any legal or compliance risks for the investor. 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 nor confirmation that any particular investor may lawfully buy, sell or hold the asset or an index containing the 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.
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.
This document may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
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 data requires a licence from FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB, BR and/or their respective licensors.
