Improving ESG data sets, regulatory frameworks and index building techniques can help ETF investors create more “bespoke” ESG allocations, Stephanie Rowton, head of sustainability indices for EMEA at S&P Dow Jones Indices (SPJDI) has said.
Rowton (pictured) said the “improving” data landscape is helping to create more ESG options for clients who are looking for more sophisticated ways to integrate sustainable investments into their portfolios.
“ESG data is improving which creates many more options for clients, who are now looking to integrate more ESG objectives,” she said.
“Some partners want indices to be able to measure more ESG elements, but at the same time they want to ensure they have a broad diversified underlying index, which may help enable investment products that are tied to the index and minimise deviation from the parent index.”
Rowton said there were two ways to build an ESG index. Firstly, the traditional “iterative approach” used for the S&P 500 ESG and S&P 500 ESG equal-weight indices, which reflect broad-beta exposure. The S&P 500 ESG Index now has over $11bn in assets under management in linked investment products tracking it since its launch in 2019.
Secondly, Rowton said clients are looking for a “bespoke index” which reflects a more tactical construction in regards to regions or sectors.
She added that clients are increasingly looking to decarbonise within their sector exposure by using climate transition benchmarks, targeting a reduction of 30% less carbon intensity versus the parent index.
In order not to exclude, underweight or overweight certain companies from the index while reducing the carbon intensity in certain sectors, SPDJI has developed an ‘optimisation’ approach.
The framework is intended to enable the “index to remain as close to the parent index as possible” while giving “more transparency” about why a company has been overweighted or underweighted versus a traditional methodology that may result in more performance dispersion.
“This approach gives users more transparency while potentially enabling the achievement of multiple objectives at the same time,” Rowton said. “We have designed an approach looking to reduce active share, trying to ensure the index remains as close to the underlying benchmark as possible.
This approach will penalise companies that veer too far away from industry, country or sector bets while integrating ESG constraints. A traditional approach looks to reduce the risk factors, .”
Room for data improvement
While data quality has been on an upward trajectory over the past couple of years, there are still several areas where improvements are coming.
Rowton said themes such as biodiversity – an area attracting an increasing amount of investor interest – may be a growing trend in 2024 and 2025 as companies start improving their data disclosures.
Other challenging areas include emerging markets, which have seen increased inflows not necessarily captured by ESG indices because of less data availability. However, Rowton said this could change in the future as the data landscape evolves.
“Some of the issues around data in emerging markets can be temporary,” she said. “We can expect to see the index availability grow as the data gets better.”