Northern Trust’s exchange-traded fund division FlexShares has introduced two new ETFs that target the equities of firms listed in the US or globally with high environmental, social and corporate governance scores.
The new FlexShares ethical ETFs screen stocks on a narrow range of key ESG metrics including carbon emissions reduction, the role of women in the company, and policies against child labour.
The FlexShares STOXX US ESG Impact Index Fund (NASDAQ: ESG) and FlexShares STOXX Global ESG Impact Index Fund (NASDAQ: ESGG) aim to provide enhanced risk-adjusted returns by reducing portfolio exposure to specific stocks with operational risks associated with poor ESG scores.
Shundrawn Thomas, head of Northern Trust’s Funds and Managed Accounts Group, said: “Investors are increasingly seeing ESG exposure as a core element of their portfolios that allows them to invest the way they live – that is, to invest in sustainable companies – while also focusing on reducing portfolio risk and enhancing long-term growth…. The launches of ESG and ESGG allow investors to incorporate sustainable investing values into their investment strategy as a core portfolio element.”
The ETFs track the STOXX US ESG Impact Index and the STOXX Global ESG Impact Index, respectively.
Both indices offer broad market exposure that is tilted towards companies scoring better ESG key performance indicators (KPIs). The indices are weighted by free-float market cap combined with a cap factor that depends on a company’s aggregate ESG KPI score. All components are subject to a cap of 5%.
Stocks excluded from the index include all companies that do not adhere to the UN Global compact principles, are involved in controversial weapons, or are coal miners. All remaining companies are assigned an aggregate score based on their performance in five KPIs: fulfilment of the CDP emission reduction target, number of independent board members, number of women on the board, policies against child labour, and the existence of golden parachute agreements.
The companies are then ranked by their aggregated ESG scores with the top half building the composition list. The companies on the composition list are grouped into quintiles by their respective aggregated ESG score and are assigned cap factors ranging from 1.5 to 0.5 in 0.25 increments. The companies are weighted by the product of their free-float market cap and the cap factor.
The STOXX US ESG Impact Index is up 9.0% year-to-date (26 July 2016) compared to 6.0% for the S&P 500, while the STOXX Global ESG Impact Index has also produced a superior return of 5.1% YTD compared to 3.3% for the MSCI ACWI.
“The STOXX ESG Impact Indices provide a broad market exposure to the companies that score superior with respect to a carefully selected set of environmental, social, and governance KPIs which are found to positively impact shareholder equity,” said Matteo Andreetto, chief executive officer, STOXX Limited. “Our methodology directly links sustainability policies with the volatility of underlying share prices. Thus, the indices offer investors a unique and innovative way to increase sustainability in their portfolio.”
The FlexShares STOXX US ESG Impact Index Fund has 269 holdings with significant exposure to the information technology (23.5%), financials (15.3%), health care (14.8%), consumer staples (12.3%) and consumer discretionary (10.6%) sectors. The gross expense ratio is 0.33% and the net expense ratio is 0.32%, in place until July 2017.
The FlexShares STOXX Global ESG Impact Index Fund has 656 holdings with significant country exposure to the US (56.8%), Japan (9.2%) and the UK (8.3%). The largest sector exposures are to information technology (17.6%), financials (15.7%), health care (14.9%), consumer staples (13.6%) and industrials (11.8%). The gross expense ratio is 0.43% and the net expense ratio is 0.42%.
While there are a number of indices offering investors sustainable investment exposure, the number of ETFs available for UK investors with this thematic exposure remain fairly limited. Those who do have such funds include iShares, who recently launched the iShares Sustainable MSCI Emerging Markets SRI UCITS ETF (LSE: SUSM) and the iShares Sustainable MSCI USA SRI UCITS ETF (LSE: SUAS) which track large- and mid-cap companies from emerging markets or in the US respectively which have been screened according to MSCI’s ESG ratings system. The ETFs have TERs of 0.35% and 0.30%. The firm also offers the iShares Dow Jones Global Sustainability Screened UCITS ETF (LSE: IGSU) which provides worldwide exposure with a focus on sustainability screened equities. TER – 0.60%.
Another is UBS, who offers the UBS MSCI USA Socially Responsible UCITS ETF (LSE: UC46) which has a TER of 0.33%, and the UBS MSCI World Socially Responsible UCITS ETF (LSE: UC44) which has a TER of 0.38%.
Interest in ESG, or ethical investing has surged in the last two years. According to data from BlackRock, global assets under management in ethical ETFs has risen nearly 45% since 2014.