Sustainable Financing Newsletter

Issue
04

The Best of Both Worlds ?

A significant recent landmark for the Environmental, Social and Governance (ESG) movement was the launch in November 2016 of a new initiative which is an innovative fusion of two increasingly popular investment techniques.

The first is the construction of indices and portfolios that are compatible with increasingly demanding environmental, social and governance (ESG) standards. Driven by a conviction that climate change presents a formidable threat to future generations, products that invest in line with green principles have been gaining traction for several years, especially among younger savers.

The second factor is smart beta investing, a transparent, rules-based and generally low-cost means of constructing portfolios based on the identification of fundamental drivers of value, which may include size, value, momentum, quality and low volatility.

In November, HSBC Bank Pension Fund Trustees, alongside Legal and General Investment Management (LGIM), FTSE Russell and the investment consultant, Redington, announced the launch of the Legal & General Future World Fund, a factor-weighted, passive global equity strategy. The four performance measures used in the strategy are value, quality, size and low volatility, while climate change tilts are embedded into the benchmark index [the FTSE All World (ex Controversial Weapons) Climate Balanced Factor Index] through the exclusion of companies in sectors contributing directly to global warming, such as coal miners. The component companies in this index have 69% fewer carbon reserves, 28% fewer carbon emissions and 105% more green revenue than those in the FTSE All World benchmark.

Investment performance does not necessarily need to be negatively impacted by any of these tilts. This is critical, because although investors are increasingly demanding that funds are allocated responsibly, they are not necessarily prepared to compromise on performance as a trade-off for sustainable investment. A recent LGIM survey of savers found that while most expressed a commitment to support responsible companies through their investments, 33% of respondents indicated that they were not prepared to sacrifice 1% of annual returns in order to do so1.

Empirical evidence suggests that factor-based strategies are capable of delivering superior risk-adjusted returns to passive index-tracking products, but this is not guaranteed. The FTSE All World (ex Controversial Weapons) Balanced Factor Index on which the LGIM strategy is based, outperformed the FTSE All World Index between September 2001 and March 2016, returning 9.69% p.a. gross, compared with 7.05% p.a. gross and with lower volatility of 14.8% p.a. compared to 16.2% p.a. of the traditional market capitalisation index. N.b. Past Performance is not a reliable indicator of Future returns

HSBC Bank UK Pension Scheme has transitioned the £1.85bn equity component of its defined contribution (DC) default investment strategy to the new LGIM Future World Fund.

Mark Thompson, the Chief Investment Officer, of the HSBC Bank UK Pension Scheme, was a key driver in the creation of the new indices and Fund.

Thompson said, “We believed that investing in the Future World Fund was in best long term interest of our members for three reasons:

  • It aims to provide a better risk adjusted return than for a conventional market capitalisation index.
  • The inclusion of the climate factor tilts, which gives our members greater exposure to companies which could be at less risk from climate change in the future. This is especially important as 60% of our members are under 40 years old and will be invested in the fund for decades to come.
  • Due to the enhanced company engagement that LGIM will offer through its climate impact pledge.”

LGIM’s commitment to engagement with the corporate sector through its climate impact pledge was covered in FTfm in November 2016. “LGIM is planning to use its clout as the UK’s largest investment manager to vote against the chairmen of companies that perform poorly on its environmental scores across all its funds.”

1 www.pensions-expert.com, November 9 2016

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Chapter
04

The Best of Both Worlds

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