When it comes to ESG indices, different objectives require different solutions. Indices can range from simple to sophisticated, concentrated to benchmark-like, broad environmental, social and governance to climate-focused, and more. Our growing suite of ESG indices aims to serve a wide range of ESG needs and support the alignment of investments with ESG principles.
When assessing ESG indices, users may have two questions.
- What is the investment objective in terms of:
- ESG benefits; and
- Active risk?
- Given the objective, which approach is more suitable:
- Simple; or
Here, we focus on these questions by highlighting the outcomes achieved by S&P 500® ESG Indices.
ESG Benefits and Active Risk
ESG benefits and active risk are two important factors to be considered within any ESG index strategy. There is generally a trade-off between the ESG benefits achieved by the index and its active risk relative to the benchmark; hence, the two aspects should be looked at collectively. When viewing ESG enhancements through an active risk lens, we can assess how much improvement in S&P DJI ESG Scores the index achieves per unit of tracking error.1 Exhibit 1 shows S&P DJI ESG Score improvement against three-year tracking error, with the bubble size representing carbon intensity reduction.2
If the objective is to achieve high ESG score improvement per unit of tracking error, the S&P 500 ESG Tilted Indices (with various tilting levels) were efficient in meeting this goal. Within the various ESG series, the high-conviction S&P 500 ESG Elite Index led the way for S&P DJI ESG Score improvement, realizing similar carbon intensity reduction to its S&P 500 ESG Leaders Index counterpart, albeit with a higher tracking error. The flagship S&P 500 ESG Index stood firmly as the sustainable, benchmark-like option, with relatively low tracking error. Likewise, if carbon intensity reduction is required, the S&P PACT™ Indices (Paris-Aligned and Climate Transition Indices) achieved that most efficiently, while aligning with the Paris Agreement goals.
How have all the S&P 500 ESG Indices performed? The S&P PACT Indices are among the notable outperformers (see Exhibit 2).
Level of Sophistication
We saw how different ESG indices have reached specific ESG outcomes. But which approaches could be used to achieve those objectives? Exhibit 3 shows the spectrum of sophistication of S&P ESG Indices.
Simpler exclusions-based indices, such as the S&P Sustainability Screened and S&P Fossil Fuel Free Indices, remove companies involved in specific business activities. Going one step further, some strategies combine exclusions with a single ESG or climate objective, such as increasing exposure to best ESG performers (S&P ESG and S&P ESG Tilted Indices) or to low-carbon emitters (S&P Carbon Efficient Indices). When multiple ESG and climate considerations are required, a sophisticated approach like the S&P PACT Indices might be more appropriate.
Our growing suite of S&P ESG Indices could help provide clients with the necessary tools to navigate the diverse and evolving nature of ESG needs. When assessing ESG indices, it’s essential to consider the required investment and ESG objectives. Again, there’s an ESG solution for every need.
1 Tracking error is calculated as the standard deviation of monthly excess returns of the ESG strategy relative to the benchmark.
2 Carbon intensity is calculated using operational and first-tier supply chain GHG emissions, please see here for more information.
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