By Mark Barnes, head of investment research (Americas)
Investors are increasingly looking for ways to align their investments with their personal environmental and societal values without resorting to complicated strategies. Our recently published research paper 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.
The research paper presents individual six-year case studies for the FTSE US All Cap Choice and FTSE Global All Cap ex US Choice indexes, two market-capitalization-weighted indexes employing a rules-based methodology that enables investors to apply robust ESG-values-based exclusions to a broad market index.
While the Global Choice screening process can have a significant impact on the composition of certain industries or countries, our research found that the overall long-term effect on index performance was minor, 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 values in portfolios.
For illustrative purposes, we present the performance statistics for the FTSE US All Cap Choice Index, which uses the FTSE USA All Cap benchmark as a starting universe, for the six-year period ended March 31, 2021. As shown, US Choice outperformed the underlying benchmark’s annualized gain of roughly 13.7% by 1.40 percentage points, with comparable volatility. The tracking error over this period was 1.26%.
Performance statistics – April 2015 to March 2021 (USD)
Source: FTSE Russell. Data based on monthly returns from April 1, 2015, through March 31, 2021. Past performance is no guarantee to future results. Please see the end for important disclosures.
For a better sense of the stability of co-movement between the two indexes, we also calculated correlations over a rolling two-year period. As shown below, though the correlation briefly dipped below 0.99 earlier in the period ‒ owing primarily to the US Choice’s underweight to Energy as a result of the ESG screening process ‒ it has stabilized around a high of around 0.998 more recently. Our research revealed similar results for the FTSE Global All Cap ex US Choice Index.
Correlation – FTSE US All Cap Choice Index to FTSE USA All Cap benchmark
Source: FTSE Russell. Data through March 31, 2021. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
The chart below plots the annualized volatility of the US 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 US Choice index has tightly matched that of the benchmark over time. Again, this suggests that the US Choice index is a good substitute for the underlying benchmark.
Annualized volatility – FTSE US All Cap Choice Index and FTSE USA All Cap benchmark (24-month-rolling window)
Source: FTSE Russell. Data through March 31, 2021.Past performance is no guarantee of future results. Please see the end for important legal disclosures.
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