The debate around whether investors must choose between targeting pure performance or bringing about positive change is quickly running out of steam, thanks to growing empirical evidence.
This rapid progress within sustainable investing – and the collection of data -- means investors can look to invest in line with their values and not compromise on returns.
While we can see clear societal pressure growing around environmental, social and corporate governance (ESG) issues, a rise in regulatory action in certain parts of the world has made them an important feature in the investment process. Looking to the long term, there is a growing sense of urgency around many of the issues encapsulated within ESG, and which are likely to be important catalysts for future performance.
Figure 1. Source: Mercer Delegated Solutions Europe Sustainable Investment Policy
A broad range of stakeholders have begun incorporating sustainability considerations into their decisions and actions. We believe this is leading us to a key tipping point around ESG investing.
There are many ways to invest in sustainable equities, but most strategies typically offer typical features that help achieve your goals (fig. 2). Both active and passive strategies tend to include exclusions of activities that don’t align with sustainable investment values (e.g. controversial weapons companies) and usually target a reduction in the portfolio’s carbon footprint.
However, active and passive strategies can differ significantly in their underlying holdings.
Many sustainable passive strategies use ESG based tilting to adjust the market cap weights of the underlying holdings. This means they should allocate more capital to companies with good ESG characteristics – such as a having a defined carbon reduction strategy or launching community outreach programmes -- and allocate less to those without. It is important for investors to note that this is a key differentiator between passive strategies. Their performance against a doing “well” or “good” benchmark will likely depend on the materiality and quality of the ESG data they use.
On the other hand, active strategies take a much more targeted approach, focusing on finding companies that are providing legitimate solutions to real world sustainability challenges. Within this group, there is a broad range to choose from, spanning development of alternative energy solutions to strengthening water and irrigation infrastructure.
Figure 2. Source: Mercer. Typical features of active and passive sustainable equity strategies. Features may vary by index provider and asset/investment manager.
Most major global ESG & sustainable indices, have outperformed the MSCI World over five years (Fig 3), while the Solactive Sustainable Global Equity Index has significantly bettered the MSCI World since its launch in 2019. While past performance is no guarantee of what will happen in the future, there is growing evidence that incorporating an ESG/sustainable lens may be beneficial from a risk and return perspective.
It is increasingly possible that doing good with your capital and doing well financially may not be mutually exclusive.
Figure 3.Source: Databank. Returns in USD as of 30 Oct 2020 relative to the MSCI World.
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“One cannot invest directly in an index. Index performance is gross of fees and expenses an investor would incur if investing in the same securities. The above does not reflect the investment performance of any Mercer client.”
If you are considering introducing sustainability into your portfolio, you would not be alone.
Over the last 10 years, investors around the world have been increasingly interested in and allocating to sustainable strategies. The International Institute for Sustainable Development noted there had been a 68% increase in assets allocated sustainably by developed economy investors between 2014 and 2019, taking the total to $30.7 trillion.
We believe this trend looks set to continue well into the future as investors look to enable positive change with their capital – and we can help you and your portfolio to be part of it.
Sustainability is at the core of Mercer’s investment beliefs and is embedded in our portfolio construction process (fig 4). Our reference portfolios include dedicated sustainable equity strategies that increase the environmental and social sustainability profile of our clients’ investments. These portfolios also target a climate transition plan, setting targets for carbon emission reduction each year that are consistent with global policy targets.
We believe that, as investors, it’s crucial to start thinking about whether a sustainable equity allocation is suitable for your portfolio and future performance.
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ESG Integration refers to environmental, social, and governance considerations that may have a material impact on financial performance, and therefore are taken into account, alongside other economic and financial metrics, in assessing the risk and return potential of an investment. Thematic Investing involves investing with a goal, at least in part, to achieve an impact on an environmental, social, or governance issue, alongside generating return and mitigating risk.
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MSCI World Index
The MSCI World Index captures large and mid cap representation across 23 Developed Markets (DM) countries*. With 1,603 constituents, the index covers approximately 85% of the free ﬂoat-adjusted market capitalization in each country.
Solactive Sustainable Global Developed Equity Index
The Solactive Sustainable Global Developed Equity Index (the “Index”) is an Index of Solactive AG and is calculated and distributed by Solactive AG.
MSCI World ESG Leaders Index
The MSCI World ESG Leaders Index is a capitalization weighted index that provides exposure to companies with high Environmental, Social and Governance (ESG) performance relative to their sector peers. MSCI World ESG Leaders Index is constructed by aggregating the following regional Index MSCI Paciﬁc ESG Leaders Index, MSCI Europe & Middle East ESG Leaders Index, MSCI Canada ESG Leaders Index and MSCI USA ESG Leaders Index. The parent index is MSCI World Index, which consists of large and mid-cap companies in 23 Developed Markets Countries*. The Index is designed for investors seeking a broad, diversiﬁed sustainability benchmark with relatively low tracking error to the underlying equity market. The index is a member of the MSCI ESG Leaders Index series. Constituent selection is based on data from MSCI ESG Research.
MSCI World Low Carbon Leaders
The MSCI World Low Carbon Leaders Index is based on the MSCI World Index, its parent index, and includes large and midcap stocks across 23 Developed Markets (DM) countries*. The index addresses two dimensions of carbon exposure – carbon emissions and fossil fuel reserves – providing clients with an effective tool for limiting the exposure of their portfolios to carbon risk. By excluding companies with the highest carbon emissions intensity and the largest owners of carbon reserves per dollar of market capitalization, the index aims to achieve at least 50% reduction in its carbon footprint. The index also aims to maintain wide and consistent market exposure by minimizing the tracking error relative to the MSCI World Index. The MSCI Global Low Carbon Leaders Indexes use MSCI ESG CarbonMetrics data from MSCI ESG Research Inc.
The Dow Jones Sustainability World Index comprises global sustainability leaders as identified by SAM. It represents the top 10% of the largest 2,500 companies in the S&P Global BMI based on long-term economic, environmental and social criteria.
FTSE4Good benchmark and tradable indexes have been designed to measure the performance of companies utilising globally recognised Environmental, Social and Governance (ESG) standards taking account of ESG risk levels, and to facilitate investment in those companies.