A "smart sustainability index" from FTSE Russell that combines performance factors with sustainability themes has won the backing of an HSBC pension fund.
The All-World excluding Controversial Weapons Climate Balanced Factor Index methodology incorporates a 'tilt' towards securities with the highest exposure to the index's four factors – value, quality, low volatility and size – and reduces exposure to companies that own or are engaged in exploration for fossil fuels, as well as to companies that emit high levels of carbon dioxide, relative to other companies in the same sector.
The methodology also increases exposure to companies that produce goods, products and services that allow the world to adapt to or mitigate the impacts of climate change, resource depletion and environmental erosion.
It excludes companies that produce 'controversial weapons', including land mines, and chemical or biological weapons.
Legal and General Investment Management (LGIM) selected the index for its Future World Fund, while HSBC Bank UK Pension Scheme chose the LGIM fund for its equity default option, which is worth £1.85 billion, in its direct contribution (DC) scheme.
The index has a 90% lower exposure to carbon reserves, a 43% reduction in exposure to carbon emissions and an 83% increase in exposure to green revenues compared with its starting universe, the FTSE All-World Index, including more than 3,000 securities from developed and emerging markets.
Green revenues are determined by FTSE Russell's Low Carbon Economy data model, designed for benchmarking changes in industrial output as companies transition to a low-carbon economy.
"The index represents a new and exciting approach for the integration of ESG into passive investment strategies, and sets a new standard for DC funds," David Harris, head of sustainable investment at London Stock Exchange Group and director of ESG at FTSE Russell, told Environmental Finance.
"We wanted to dial down exposure to carbon reserves, dial down exposure to carbon emissions, and dial up exposure to green revenue"
- Mark Thompson, HSBC
The index was designed in collaboration with "extremely useful input" from HSBC and LGIM, Harris said. HSBC Pension Funds' investment consultants, Redington, also assessed the index to advise the pension fund on its suitability.
Mark Thompson, chief investment officer at HSBC Bank UK Pension Scheme, explained recently how the company worked with FTSE Russell to explain what it wanted from a 'sustainability index'.
In 2016, when HSBC was using FTSE's All-Market Cap Index, the bank identified ways to improve its main DC global equity passive fund, which has about £2 billion under management, he said.
The bank wanted to get better risk adjusted returns, to ingrain climate change protection into the fund, and to strengthen the engagement policy with the fund manager, in this case LGIM.
"We wanted to dial down exposure to carbon reserves, dial down exposure to carbon emissions, and dial up exposure to green revenue, but to do that in the context of it still being acceptable distribution of responsibility."
LGIM will also engage with companies invested in its Future World Fund in order to "bring about positive change". Those not making progress on climate-related issues in their engagements will be divested, starting from March 2018.
Harris said the index was "ground breaking in a number of ways":
- ESG integration into the default passive option for a DC fund
- A corporate, rather than public, pension fund integrating ESG into a core passive strategy
- Combining smart beta and climate into a single index solution that is used at scale
- The level of collaboration over 11 months between HSBC UK Pension fund, FTSE Russell, LGIM and Redington.
"The reception has been incredible, as the index has moved the discussion from what might be feasible to what is now available in the market," explained Harris.
"As well as the LGIM fund, FTSE Russell is seeing significant demand from asset owners for other 'smart sustainability' indexes with different combinations of risk premiums and sustainability parameters into index designs for core equity allocations.
"The new era of ESG integration into passive strategies is finally arriving," Harris said.
| Category | Winner |
|---|---|
| Personality of the Year | Thomas DiNapoli, New York State Comptroller |
| Solar | Vela Energy |
| Wind | Khalladi, Morocco |
| M&A | Total and Saft |
| IPO | Dong Energy |
| Water | Xylem/Sensus |
| Bioenergy | MGT Teesside |
| Sustainable Forestry | IFC/BHP Billiton Forestry bond |
| Energy Efficiency | SUSI Energy Efficiency Project Facility |
| Catastrophe Risk | Allianz Weather Bond |
| Weather Risk | Old Settler Wind |
| Carbon | FTSE Russell's Climate Balanced Factor Index |