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MSCI Launches ESG Index Series that Aims to Be More Inclusive

The MSCI index will exclude companies that have violated international standards on human rights, environmental and controversial weapons.

MSCI has launched an index series geared to environmental, social and governance (ESG) investing that will enable institutional investors to better integrate ESG factors into their investing process.

The MSCI ESG universal indexes aim to help such large investors be more inclusionary and universal in their approach to ESG investing, so that they have a broader universe of equity investments to draw from without giving up their ESG focus. These indices will move away from a market capitalization weighting for equities to one that takes stock of their ESG profile so as to better weigh ESG performance.

The MSCI index will only exclude such companies that it deems to have violated international standards on matters such as human rights or the environment, as well as those it considers to be involved with “controversial weapons,” such as biological and chemical weapons.

Diana Tidd, MSCI’s global head of index, said, “The MSCI ESG Universal Indexes offer the world’s largest asset owners a scalable way to integrate ESG into their investment decision-making processes. Asset owners can use the MSCI ESG Universal Indexes to facilitate asset allocation or to help implement investment strategies in accordance with their ESG goals.” 

Globally, the MSCI ESG indexes serve as a benchmark for more than $56 billion in investments, according to the New York investment-index firm.  So how does incorporating ESG factors impact investment performance? Cambridge Associates, a Boston-based global investing firm, finds that investors that incorporated ESG factors in their investments in emerging market stocks came out ahead of those that didn’t weigh such factors.

For instance, MSCI’s emerging markets ESG index beat MSCI’s emerging markets index by a total of 12% over a three-year period (beginning June 2013, when MSCI launched the emerging markets ESG index), and more than half of this outperformance is based on ESG factors.

Chris Varco, senior investment director for mission-related investing at Cambridge Associates, said: “Using these criteria to help pick stocks in emerging markets really helps to separate the wheat from the chaff. Of the 367 basis points of annualised outperformance achieved by the MSCI emerging markets ESG index, some 199 basis points were attributable to ESG factors after we accounted for the contribution of other factors such as country, currency, sector and style.”

 The sector factor contributed to 107 basis points of the outperformance, while style accounted for 63 basis points and currency for four basis points. The country factor however, lowered the ESG index’s overall return by five basis points. Another factor that positively impacted the performance of the MSCI emerging markets ESG index is that government enterprises, which figure more prominently in the MSCI emerging markets index, don’t have a big presence in the ESG index. These government enterprises are not solely focused on generating a good shareholder return and their returns are also impacted by other factors.

Cambridge also finds that the impact on quantitative returns from the incorporation of ESG factors is not so positive for investments in developed countries. Over an approximate six-year period, for instance, the MSCI world ESG index turned in a lower return, by 10 basis points, than the MSCI world index. According to Cambridge, this comes about as the ESG index excluded some large capitalization US companies such as Amazon, Apple, Home Depot and Facebook.

 That doesn’t mean that the incorporation of ESG factors is always a negative for returns in the case of developed country investments. Active investors who have used such factors alongside financial analysis have done better than the MSCI world index in recent years, Cambridge report.

By Poonkulali Thangavelu

Related Link: ESG is Key to Outperformance in Emerging Markets.