Already prior to the introduction of ESG as a compelling investment approach, another relevant development took place in the financial sector: indexing. Advances in technology and finance have today made it possible to create an index quickly and efficiently using virtually any criteria whatsoever, an index that can be exactly replicated in a corresponding passive fund.
That index funds replicating indices based on ESG criteria have been used by investors to aid in their investment decisions is no recent phenomenon.
The index revolution
A wide range of indices are available today that variously weight environmental and governance-related aspects. We see them as falling into four categories: Indices that focus on climate change, indices that base their selections on religious and ethical convictions, indices based on specific objectives such as the promotion of women within corporate structures, and diversified indices that more or less cover the entire ESG spectrum. Credit Suisse Asset Management focuses on the last category for its investment solutions.
The MSCI indices serve as the underlying. MSCI is one of the largest and most prominent index providers in the world. The MSCI ESG Leaders indices are broadly diversified, replicate a wide array of sectors and moreover exhibit a lower tracking error relative to the respective (non-ESG) standard index.
The MSCI ESG Leaders indices achieve this by means of a multi-stage process. First, they exclude outright any company that derives more than 50% of its revenues from controversial business areas such as alcohol, tobacco, gambling, nuclear power or firearms. The remaining companies are subjected to a detailed analysis based on publicly available data sets, e.g. business reports, NGO studies and other trustworthy third-party sources.
The outcome of this analysis is an in-house ESG rating. To attain best-in-class status, companies must achieve an ESG rating of “BB” and score at least “3” on a scale of controversial business practices. The companies with the best ESG scores are included in the ESG Leaders Index, targeting a representation of 50% of the market capitalization in each sector. This ensures that the ESG indices do not stray too far from the standard indices at the return and risk level.
Last year, we highlighted the Education sector as having one of the lowest adoption rates of digital technologies. At only 2-3% of total spending in the education sector, it is a lower level than practically every other sector of the modern economy.