ESG Integration for Passive Managers:Opportunities and Challenges
Kensuke Niihara
Managing Director,
Chief Investment Officer - Japan
State Street Global Advisors (Japan) Co., Ltd.
4
ESG Integration for Passive
Managers:
Opportunities and Challenges
Kensuke Niihara
Managing Director, Chief Investment Officer - Japan
State Street Global Advisors (Japan) Co., Ltd.
5
Contents
Current Status of Passive Investment
- Background of Growth in Passive
- Criticism to Passive
Role of Passive Investment for ESG Expansion
Desirable Conditions for ESG Index
Examples of ESG Index Construction
6
Source: Morningstar Direct, as of December 31, 2017.
Mutual Fund data is exclusive of Money Markets and Fund of Funds.
13 16 2437
87 84 7663
0102030405060708090
100
2001 2005 2010 2017 YTD
Mar
ket
Shar
e(%
)
Passively Managed Actively Managed
Active and Passive Industry Market Share
US Mutual Fund Market
Growth of Passive Management
Maturing Market
7
Growth of Passive – Demand Side Factors
Cost
Lower expected return
Longer investment
horizon
Efficiency
Decreased alpha opportunity
Multiple active resulted in
expensive passive
Transparency
Requirement for
enhanced accountability
8
Growth of Passive – Supply Side Factors
Enhanced Portfolio Management Techniques
Cost Management
Flexible and practical
control of index deviations
Alpha
Pursue systematic
return opportunities
Index Construction
Customization
9
Criticism of Passive -1
Criticism
RealityIncreased demand for customized indices, not traditional ones
AnswersPassive is effectively the implementation of Asset Owner’s active decisionsT
Asset owners are solving issues themselves rather than relying on active investment
Passive investing is distorting the market
10
Criticism of Passive -2
Criticism
RealityPassive Managers are not allowed to select issuers and provide nearly permanent
capital
AnswersPassive Managers have obligations to foster long term market growth
Passive Managers are not active owners
11
Passive Investment – Future
The trend is supported by both demand and supply
factors and is unlikely to reverse
12
How to Expand ESG Investment
Need ESG integration in passive management
Need appropriate benchmark index to implement
ESG
13
What is Required for an ESG Index -1
Direct Requirements
Transparency
ESG Scoring System
to which Asset Owners,
Investment Managers and
Issuers have access
Fairness
Reliable
Multiple data sources
Effectiveness
Evaluate ESG factors
important for long term
performance
Sector/industry specific
= Financial Materiality
14
What is Required for an ESG Index -2
Indirect Requirements
Policy
BenchmarkLimited impact on strategic
asset allocation
Solution
Flexibility for
customization to reflect
Asset Owner’s interests
Stewardship
Integration with stewardship
activities
(voting and engagement)
15
ESG Scoring Model -1: Regarding E&S
Financially material E&S factors are industry specific
- Introduce “Materiality Map” to reflect financially material
factors for each industry
- Use multiple ESG data sources
16
Why Use Multiple Sources
Sustainalytics MSCI Robeco SAM Bloomberg
Sustainalytics 1.0 0.53 0.76 0.66
MSCI — 1.0 0.48 0.47
RobecoSAM — — 1.0 0.68
Bloomberg — — — 1.0
( As of June 2017)
Cross-Sectional Correlation for Constituents of the MSCI World Index
ESG Scores are Different Across Providers
(11 Sectors / 77 Industries)
(5 Sustainability Dimensions/
26 General Issue Items/
200+ Environmental and Social Specific Topics)
17
- Transparent framework widely
supported by Investors and
Issuers
Y
N
: Likely a material issue for
companies in the industry
: Not Likely a material issue for
companies in the industry
ESG Materiality Map - SASB**Sustainable Accounting Standards Board
Evaluate Financial Materiality for more than +200 ESG items by 77 industries
18
ESG Scoring Model -2: Regarding G
Governance practices are market specific as they are
based on legislation, regulation, ethics business norms,
etc.
- Reflect country-level corporate governance codes
developed by local regulators or Investors
19
ESG Scoring Model -3: ExampleIntegrated Model
Best-in-class
Multiple Data Source
Sustainalytics
Vigeo EIRIS
ISS ESG
E/S Scoring Model
= Materiality Map
ISS Governance
Governance Scoring Model
SASB (Sustainable Accounting Standards Board)
Integrated ESG
Score
Optimization(Control of Tracking Error)
Example of ESG Index Construction -1Construction Process (US Large Cap)
20
Base Index
-15Score
Missing
Number of
Constituents
ControversyMissing Data
Exclusions Screening
181
Eligible for
ESG Index
508 459-5Extreme Event
Controversies
-2Controversial
Weapons
-0Thermal Coal
-18UNGC
Violations
-6Tobacco
-0Civilian
Firearms
Final
ESG Index
Source: SSGA, Bloomberg as at June 30, 2019. For illustrative purposes only.
The characteristics shown are not intended to represent the characteristics of any particular security or other investment.
OptimizationConstraints :Control of TE, Sector/Issue weight
Objective : Maximization of ESG Score
- Flexible customization on Screening, Active Risk and ESG Outcomes
15.9%
34.1%32.1%
10.0%
3.1% 4.7%
Leaders Outperformer
Average Underperformer
Laggard n/a
39.8%
48.1%
9.4%2.8%
ESG Index
(BESGOX) 70.16
US Large Cap
Equity Index
(B500T) 62.89
21
Index Characteristics & ESG Score
ESG Index US Large Cap Index
Source: Bloomberg, Factset, State Street Global Advisors as of 06/30/2019.
Example of ESG Index Construction -2Better ESG Score (US Large Cap)
Example of ESG Index Construction -3Performance Back-test (US Large Cap)
Since
Inception
%
Volatility
%
Tracking
Error
%
Beta
ESG Index
(BESGOXT Index)
Back-tested
11.7 11.8 1.14 1.00
S&P500 Index 11.3 11.8 - -
22
Source: Bloomberg, Factset, State Street Global Advisors as of 06/30/2019, calculated using monthly
total returns in USD. The inception date of each of the ESG Index (Bloomberg SASB ESG Select ex
Controversies US Large Cap Index) is 3/25/2019. Pre-inception index performance shown above is
back tested (hypothetical) performance and is not a guarantee of past or future results. Actual
performance of any investment may have differed substantially from the back-tested performance
presented, as the performance was calculated with the benefit of hindsight and cannot account for all
financial risk that may affect the actual performance. Performance prior to the inception date of the
index referenced herein is derived from actual performance of underlying index constituents weighted
according to the index's predefined methodology, taking into account rebalancing schedules. Indices
are unmanaged, are not subject to fees and expenses, and are not available for direct investment. Past
performance is not a guarantee of future results.
Back-tested Performance (USD)From March 31 2014 to June 30 2019 (Annualized)
-2%
0%
2%
4%
6%
8%
10%
-20%
0%
20%
40%
60%
80%
100%
2014/3 2015/3 2016/3 2017/3 2018/3 2019/3
ESGインデックス(バックテスト)
S&P500
収益差(右軸)
ESG Index (Back-test)
S&P 500 Index
Return Difference (RHS)
Example of ESG Index Construction -4Performance Back-test (US Investment Grade Corporate Bond)
Since
Inception
%
Volatility
%
Tracking
Error
%
Beta
ESG Index
(I35146US Index)
Back-tested
4.54 3.90 0.30 0.99
Bloomberg US Corporate
Index4.40 3.94 - -
23
Source: Bloomberg, State Street Global Advisors as of 06/30/2019, calculated using monthly total
returns in USD. The inception date of each of the ESG Index (Bloomberg SASB ESG Select ex
Controversies US Corporate Index) is 2/28/2019. Pre-inception index performance shown above is
back tested (hypothetical) performance and is not a guarantee of past or future results. Actual
performance of any investment may have differed substantially from the back-tested performance
presented, as the performance was calculated with the benefit of hindsight and cannot account for all
financial risk that may affect the actual performance. Performance prior to the inception date of the index
referenced herein is derived from actual performance of underlying index constituents weighted
according to the index's predefined methodology, taking into account rebalancing schedules. Indices
are unmanaged, are not subject to fees and expenses, and are not available for direct investment. Past
performance is not a guarantee of future results.
Back-tested Performance (USD)From March 31 2014 to June 30 2019 (Annualized)
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
2014/3 2015/3 2016/3 2017/3 2018/3 2019/3
ESG社債インデックス(バックテスト)
バークレイズ米国社債インデックス
収益差(右軸)
ESG IG Corporate Index (Back-test)
Bloomberg Barclays US IG Corp
IndexReturn Difference (RHS)
24
Integration with Stewardship
Even in Passive Management,
we should look for synergy between an ESG index and
stewardship activities
- Refer to ESG score used in the index during engagement
- Foster improved ESG practices and disclosure through the
score
Increasing Role for Passive Management
Passively Managed ESG Investment is a key to Expand ESG Investment
Need for ESG Index
- ESG Scoring (Multiple Data Sources, Effective Materiality Map)
- Control of Tracking Error
Integration with Stewardship Activities
Customized Solution to meet each Asset Owner’s Interests
25
Summary
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