• Vector Insights

    Your investment can be part of the solution

    Russell Grigg, General Counsel and Head of Compliance
    09 March 2018
     

    Sustainable investing is not new.

    From the 18th Century, the Quakers and Methodists advocated certain standards of behaviour and treatment, including the abolition of slavery, fair employment conditions and avoiding alcohol and gambling. This informed the investment values of both groups.

    In the 1960s, the Vietnam War prompted thousands of people in the US to boycott companies that produced weapons used in the war. Meanwhile, the civil rights movement prompted people to voice concerns about investing in companies not recognising human rights. Following soon after, in 1971 Pax World created what it claims was the first socially responsible investment (SRI) fund in America.1

    In the 1980s, environmental concerns gained more attention as global warming became a greater focus. Disasters such as Bhopal and Exxon Valdez forced people to realise just how much harm corporations could do if they did not act responsibly. Thousands of people in the Indian city of Bhopal died in 1984 from poisonous gases leaked from a nearby Union Carbide plant. The Exxon Valdez oil spill in Alaska in 1989 was, at the time, the worst human-caused environmental disaster resulting in the deaths of countless wildlife, destruction of habitats and economic devastation to a mass of coastal businesses. Both highlighted the great harm negligent companies can cause to human life, the community, animal life and environment.

    These lessons weren’t heeded by BP which was responsible for the deadly Deepwater Horizon oil rig disaster in 2010. BP was ruled to be “grossly negligent” and was forced to sell assets to cover its costs which exceeded US$61 billion.

    Consideration of these kinds of risks associated with a company’s business activities has become part of both the quantitative and the qualitative investment processes of professional fund managers. Prior to the GFC, the United Nations launched the Principles for Responsible Investment (PRI) initiative. The Principles were developed by investors, for investors, to contribute to developing a more sustainable global financial system. The PRI now has more than 1,800 signatories, including VanEck, from over 50 countries, representing approximately US$70 trillion.2

    The PRI initiative believes that “an economically efficient, sustainable global financial system is a necessity for long-term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society as a whole.”

    Sustainable investing has evolved as an approach to investing that drives positive social or environmental impacts alongside long-term financial results.

    It does this by taking environmental, social and governance (ESG) factors and ethical considerations into account when making investment decisions, to better assess and manage risk with the aim of generating sustainable, long-term returns from socially responsible investments (SRI).

    The result is an alignment of investor values with their investment objectives.

    Incorporating socially responsible investing (SRI)
    SRI, if we apply it like the early Quakers and Methodists did, generally involves ‘negative screens’ by excluding investments in companies involved in such business activities as gambling or pornography or the production of tobacco, alcohol, military weapons and civilian firearms and gambling.

    These screens are quantitative. It is relatively easy to identify whether a company is involved in these activities from publically available data such as annual reports. Companies deriving income from these sources can be excluded from a portfolio. There are many portfolios that only exclude companies because of such anti-social or irresponsible activities.

    Incorporating Environmental, social, and corporate governance (ESG)
    Considering ESG factors in investment decision-making is both quantitative and qualitative.

    An example of a quantitative approach when considering the environment is assessing fossil fuel reserves and carbon emissions. Climate change is one of the largest economic and political challenges of the 21st century. Investors are now interested in a company’s carbon dioxide emissions (CO₂e) and their reserve of fossil fuels. Like SRI, these are able to be identified and measured. Stock exchanges around the world are increasingly forcing listed companies to report this data. Companies can therefore be excluded from portfolios if they have reserves of fossil fuels or are deemed to be ‘carbon criminals.’ Examples of institutions that have committed to some fossil fuel exclusions, are the Norwegian Sovereign Wealth Fund, CalPERS, and a large number of universities.

    Harder to quantify are environmental, social, governance factors. Factors such as labour standards, workplace diversity, efficient use of scarce resources, risk controls, management competency and environmental impacts are difficult to identify from annual reports. Therefore qualitative analysis is required so that investors can identify:

    • companies that are ESG leaders, that should be considered for investment and
    • companies that are laggards, that should be avoided.

    ESG analysis can help investors avoid controversies such as the Volkswagen emissions scandal by only investing in ESG leaders. Avoiding Volkswagen in portfolios not only had a social impact, it protected people’s investments when Volkswagen’s share price crashed.

    Many active fund managers incorporate ESG factors into their risk analysis. However, the challenge for many investors has been combining the inclusion of ESG leaders, exclusion of fossil fuels and carbon criminals and the exclusion of companies involved in anti-social or irresponsible activities into one portfolio. Many investments do only one or two of these. It has been particularly hard for passive managers, who track indices, to include effective qualitative ESG research.

    Until now.

    Index innovation broadens sustainability offerings
    Enter MSCI, one of the world’s largest index providers. MSCI has a team of over 170 analysts worldwide assessing all of the stocks in its global universe on a ‘AAA’ to ‘CCC’ scale according to their exposure to industry specific ESG risks and their ability to manage those risks relative to peers.    

    As an index provider, MSCI is also able to assess and retain data on each company’s fossil fuel reserves and CO2e impact as well as their business activities.

    MSCI has developed four focused approaches:

    1. ESG Universal Indices - enhancing exposure to those companies that demonstrate both a higher MSCI ESG Rating and a positive ESG trend, while maintaining a broad and diversified investment universe. These indices exclude companies found to be in violation of international norms and companies involved in controversial weapons.
    2. Low Carbon Indices - launched in 2014, they are the first benchmark series designed to address two dimensions of carbon exposure: carbon emissions and fossil fuel reserves.
    3. Index Carbon Footprint metrics - for investors who are looking to understand, measure and manage carbon risk in their portfolios.
    4. ESG Leaders Indices - targeting companies that have the highest ESG rated performance.

    Based on this work MSCI is regarded as the leading ESG research provider in the world.

    VanEck has partnered with MSCI to create a state-of-the-art index that combines all of MSCI’s ESG and SRI data and expertise. The resulting index incorporates both values-based and impact investing.

    The Index: MSCI World ex Australia ex Fossil Fuel Select SRI and Low Carbon Capped Index (ESGI Index)

     

    Companies in the ESGI Index are selected from the MSCI World ex Australia Index through a four-step screening process based on:

    1. Fossil fuels exclusion
      Companies that have proved and probable coal reserves and/or oil and natural gas reserves used for energy purposes are excluded.

    2. Socially Responsible Investing (SRI) exclusion
      Companies whose businesses are involved in or exposed to the following activities are excluded:
      • alcohol
      • gambling
      • tobacco
      • military weapons
      • civilian firearms
      • nuclear power
      • adult entertainment
      • genetically modified organisms (GMOs).
    3. High rating ESG inclusion
      MSCI ESG Research data is then used to include only the leading ESG performers in each GICS sector.
    1. High carbon emitters excluded
      Remaining companies from step 3 are then ranked by carbon emission intensity and the top 20% by number are excluded. The cumulative weight of securities excluded from any GICS sector is capped at 30% of the weight of the sectors from step 3 so that sector weights are not excessively disrupted.
      Securities are also excluded until the cumulative potential carbon emissions of the excluded companies reaches 50% of the sum of the potential carbon emissions of the constituents remaining from step 2.

    The result is the most comprehensive, in depth, ‘dark green’ index in MSCI’s ESG family.

    Source: MSCI, as at 31 January 2018

    VanEck Vectors MSCI International Sustainable Equity ETF (ASX: ESGI) tracks the ESGI Index and it started trading on ASX last week.

    Now those large institutions who have committed to sustainable investing as well as the growing movement of individual investors who want to align their investments to their ethics and values can access a portfolio of ~200 international ESG leaders in a single trade on ASX.

     

    IMPORTANT NOTICE: This information is prepared in good faith by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’) as the responsible entity and issuer of VanEck Vectors MSCI International Sustainable Equity ETF ARSN 623 953 177 (‘ESGI’). This information is general in nature and not financial advice. It does not take into account any person's individual objectives, financial situation or needs. Before making an investment decision investors should read the product disclosure statement and with the assistance of a financial adviser consider if it is appropriate for their circumstances. A copy of the PDS is available at www.vaneck.com.au. This information is believed to be accurate at the time of compilation but is subject to change. VanEck does not represent or warrant the quality, accuracy, reliability, timeliness or completeness of the information. To the extent permitted by law, VanEck does not accept any liability (whether arising in contract, tort, negligence or otherwise) for any error or omission in the information or for any loss or damage (whether direct, indirect, consequential or otherwise) suffered by any recipient of the information, acting in reliance on it. The fund is subject to investment risk, including possible loss of capital invested.

    No member of the VanEck group guarantees the repayment of capital, the payment of income, performance, or any particular rate of return from the Fund. ESGI is indexed to a MSCI index. ESGI is not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to ESGI or the MSCI Index. The PDS contains a more detailed description of the limited relationship MSCI has with VanEck and ESGI. © 2018 VanEck®


    1 https://paxworld.com/about/
    2 https://www.unpri.org/about