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Special Report

ESG: The metrics jigsaw


On the right track?

Where will SRSI investing on an indexed basis go in Europe after the Swiss Federal Social Security Fund’s massive mandate of last autumn? The Sfr500m (E340m) was the first of its kind and emerged into an investment world that was still unsure about socially responsible investing let alone doing it on an indexed basis.
“This was the largest ethical mandate that had been seen in Europe and so was something of a landmark,” says Rick Lacaille of SSGA, which won the mandate. “It was, as you would expect, a very well organised tender, with a great deal of information about process and so on.”
“Last year’s decision by the social security fund was a milestone. The mandate amounted to a third of the international equity portfolio of the fund,” says Alex Barkawi of Dow Jones Sustainability Indexes (DJSI), whose DJSI index was selected as the benchmark. “The fund came to us and told us they wanted to use our index and needed a licence.”
At the fund in Geneva, deputy managing director, Dominique Salamin says that at the time they were deliberating the question, there was not a great choice available besides DJSI. “The Domini index was not so well known in Europe and the FTSE4Good had not yet come into play.”
But the reason behind the fund’s decision fitted very well with the DJSI approach. “For our board the decision to invest in an SRI portfolio was not a political decision, it was felt that it was a good investment strategy in its own right in the long term, when an SRI approach would pay off in investment terms,” says Salamin.
Says Barkawi: “We do not say that sustainability will outperform in any particular year. It is a long term concept that we are convinced will pay off in the longer term.” So in recent months, the index has had an under performance, compared with the MSCI world, he acknowledges. The fact that 50% of the DJSI sustainability index is in European securities compared with 25% in the DJ Global means that the euro’s decline has hit performance.
The index was launched in 1999, with five years’ backtracking data, showing outperformance over the period. “This needs to be interpreted with caution,” warns Barkawi. “It was an important chart at the time, as investors believed that sustainability would lead to underperformance. Showing that this was not the case gave food for thought.”
Salamin agrees with this: “The time has been too short to say how it has performed. The index has lived up to our expectations, but there has been some higher turnover than expected.” But he did not think this had caused the index asset manager too many problems. There is the cost of licensing the index, which is something he says he was not aware of in the other indexed portfolios of the fund, though he assumes it is built in.
From SSGA’s point of view, Lacaille says: “We knew we would need a more individual approach than for mainstream mandates and this poses some additional costs. So far the information provision has been sufficient to get the job done adequately.”
The index has a major review and assessment of it constituents once a year in October. But last at review date, DJ combined the index revision with an extension of the market capitalisation range, so there was a rule change as well, Lacaille points out. “We had a larger turnover than expected.” The previous year there had been an extensive change as well.
But Lacaille acknowledges the special nature of the SRSI area: “There is no point in having a sustainable index unless it is dynamic, as it is aimed at changing behaviour in companies and this has to be recognised. However, we did not know how high it would be. Handling a large turnover like this is not a problem for us in itself.”
Certainly with the index’s range of 250 stocks, there is no significant market impact in executing the orders over a short time. “It is certainly more labour intensive as you cannot forecast what is going to happen. But it is quite narrow in terms of number of stocks, which makes it all the more manageable.”
This range of around 250, which under the DJSI sustainability criteria is 10% of the 2,500 companies in the global universe, is causing some thoughts at the fund, where Salamin compares the 250 companies with the 1,500 in the fund’s global mandate and wonders if a broader index would be preferable.
Lacaille says: “While it is called an indexed portfolio, it is in fact an active selection of stocks by Sustainable Asset Management, who are in the fund management business.” This is what makes it so interesting from his point of view as the combination between sustainability and indexing. “It is by no means naïve screening.” But at the same time, he has no doubts that the DJSI approach is amenable to indexing methodology.
What he is not sure about is whether most investors will go down the indexing route, though some undoubtedly will. SSGA has at least one FTSE4Good index mandate. The Swedish government AP7 fund has both indexed and active approaches with negative screening. “One reason why we at SSGA use the responsible engagement overlay (REO) approach, is that along with most pension fund managers, we feel the link between sustainability and performance is too uncertain,” says Lacaille.
“While most people going the indexed route do so to anchor their performance, SRSI is a separate case. So DJSI can enter a dialogue with clients who accept the concept of the link, and are then happy to do it passively,” he adds.
DJSI believes things are going its way, with some E2.2bn either tracking its sustainable indices or using them as a universe. “We now have 37 licences with asset managers in 14 countries and there are pension fund investors behind these asset managers,” says Barkawi.

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