UNDERSTANDING ESG INDEXES

Estimated reading time: 2 min.

ESG Indexes consists of companies specifically selected based on their nonfinancial indicators in terms of Environment, Social and Governance metrics. They can be used by portfolio managers as a basis for investable products and as benchmarks to monitor their performance 

THE RISE OF ESG INDEXES

Did you know ?

The first ESG Index launched in May 1990 was the Domini 400 Social Index still active today as the MSCI KLD 400 Social Index.

Since then, ESG investing has received growing public attention, and, according to Morningstar, there are nowadays more than 50 000 ESG and sustainability indexes.

ESG INDEX CONSTRUCTION AND SELECTION

These Indexes are built with varying methodologies, the main ones being negative or positive screening: 

• A negative screening consists in excluding companies operating in specific sectors (such as alcohol & tobacco, fossil fuels....)
• A positive screening or “Best in class” consists in keeping companies based on specific indicators (Global ESG scores, carbon emissions, environmental score etc...).

PERFORMANCE MEASUREMENTS OF ESG STRATEGIES

Selecting the appropriate ESG index is a strategic decision. The chosen benchmark should align with the ESG investment approach, whether best-in-class selection, thematic strategies, or impact-driven investing. Traditional performance approaches will measure the performance of the ESG strategy by comparing the performance of the initial universe and the performance of the ESG benchmark and then use Brinson style attribution to disentangle allocation and selection effects.

Yet, given the diversity of ESG strategies, the perfect index may not always exist in the market. Philippe Grégoire proposed an innovative approach to build ESG benchmarks on the fly that match each aspects of the strategy.