New index range helps clients incorporate ESG and climate objectives into UK equity portfolios as part of a “broader mission” to build out range of country-specific indexes.
FTSE Russell’s newly launched FTSE UK ESG Risk-Adjusted Index Series combines ESG scores, carbon emissions metrics, including intensity of reserves, and exclusions in a broad ESG index series that “fills gaps” in its product range for responsible investors.
Aled Jones, Head of Sustainable Investment Solutions at FTSE Russell, told ESG Investor the new index series forms part of its plans to further expand its multi-asset ESG and climate index product range.
The new index series as “another tool in the toolbox” for clients, he said, with this index covering “broad, more obvious” ESG risks for the UK market. Client demand for such a product has increased over the past 18 months, he added.
While the index provider already has products for investors that “want to go full-on on climate”, and others for investors that are “focused on exclusions”, there is a gap for a broad ESG index, which Jones said this new product will fill.
“Our intention with this new series is to deliver something that works from both an ESG and an investment perspective while still underpinned by FTSE Russell’s transparency, robust governance, and in-depth data and research,” FTSE Russell said in a statement.
The series applies a range of product and conduct exclusions, and significantly reduces carbon emissions while reserving exposure against the underlying FTSE 100, FTSE 250, FTSE 350 and FTSE Allshare benchmarks.
Arne Staal, CEO at FTSE Russell, said it had created the FTSE UK ESG Risk-Adjusted Index Series to “further increase the options for clients incorporating ESG and climate objectives into UK equity portfolios”.
“This launch, while continuing to expand our multi-asset ESG and climate index range, is also our first ESG adjusted version of the FTSE 100, and something our customers have been asking for,” he added.
Recent data suggests product development and investor demand for passive ESG investment options has strengthened over the past 12-18 months.
Hortense Bioy, Global Director of Sustainability Research at Morningstar, recently said that ESG ETFs can now be found “on par with plain-vanilla non-ESG ETFs”. She also highlighted the lower cost and higher transparency of passive ESG strategies compared to active ones, with Morningstar’s latest European Active/Passive Barometer report branding active funds as having a “lacklustre performance”.
According to Morningstar’s recent Global Sustainable Fund Flows report, passive strategies now represent almost a quarter of worldwide ESG fund assets. It also said that in Q4 2022, passive strategies accounted for six of the 10 bestselling sustainable products globally, netting a combined US$6.7 billion of net new money.
Bioy said that the growth in passive ESG funds is a “direct result of technological advancements”, including on indexing, as well as improved ESG data. “You can’t do indexing if you do not have data. Index providers are hungry for new data – this is how you innovate.”
Robust and investable
According to Jones, the firm’s Russell US ESG index series has had its exclusions aligned with the FTSE UK ESG Risk-Adjusted Index Series as part of a “broader mission to build out a similar set of indexes in particular single country universes”.
“By shifting exposure or weights in the index to companies with better ESG scores, there’s a significant reduction in exposure to carbon emissions and carbon reserves on fossil fuel reserves,” he added.
The new index does not fully exclude investment in fossil fuel or carbon-intensive companies, as this would require exclusion of a “huge part of the benchmark” said Jones.
“Something like 20% of the weight of the underlying universe is basically energy companies and basic materials companies, most of whom own fossil fuels,” Jones added. “In doing that, you knock out quality companies and you end up at a substantially different endpoint.”
He stressed the importance of “balancing these parameters” to create an index that is “robust from a general ESG perspective, but also offers an investable outcome”.
The index series does apply a range of product and conduct exclusions, including controversial weapons, thermal coal production, energy generation based on thermal coal, Arctic oil and gas exploration, oil sands and shale energy extraction and production, tobacco production and retail, and controversial conduct.
FTSE Russell said these “significantly reduce” the carbon emissions and reserves exposure of the index against the underlying benchmark, and “tilts the weights of the universe towards companies with better ESG characteristics”.
Jones said that the exclusions of thermal coal and unconventional oil and gas sources like Arctic oil and, oil sands, and shale gas “tackle the most carbon-intensive sources of fossil fuels”.
He added that a UK index series that excludes fossil fuels is “something we could create” in response to demand, but underlined that it would be a “very different type of product”.
“We want investors ultimately to have a choice to reflect different objectives that we see in the market,” Jones said.
Jones said the new index series’ potential clients could include ETF providers, as well as other funds managers and their institutional clients, derivative providers or structured product desks.
“Our ambition is to build out our index range across fixed income and equities based on ESG and climate priorities, which includes areas like estate and listed infrastructure,” Jones said.
Financial technology firm Trackinsight’s Global ETF Survey 2023 said that investors are expanding their use of ETFs, with them offering the opportunity to “build better-suited strategies for financial markets characterised by significant uncertainty”.
Three-in-ten respondents to the survey said they planned to increase exposure to ESG-aligned and sustainable ETFs, 35% in EMEA and APAC, and 25% in the US, but the report noted that very few respondents use active ETFs for their ESG equity or their ESG fixed income strategies.