Japan GPIF’s ESG Portfolio Outperforms Market

Fund reports that four out of five ESG investments outperformed their benchmarks.

Japan’s $1.47 trillion Government Pension Investment Fund (GPIF) reported that four out five ESG indices selected by the fund outperformed their parent indices and market averages over the past two years.

The fund has approximately ¥3.5 trillion ($32.4 billion) in assets under management tracking ESG indices. The ESG indices selected by the fund include the MSCI Japan ESG Select Leaders Index, the MSCI Japan Empowering Women Index, and the FTSE Blossom Japan Index. The indices are mainly composed of medium and large-cap stocks.

The fund said in its most recent ESG report that market conditions led the MSCI Japan ESG Select Leaders Index, and the MSCI Japan Empowering Women Index to underperform the Tokyo Stock Price Index (TOPIX) over one year beginning April 2017. However, they outperformed the benchmark over two years beginning on the same date.

According to the report, performance of ESG indices can be significantly affected by factors unrelated to ESG, such as the so-called small cap effect, in which small cap stocks tend to outperform larger ones over the long-term.

The number of stocks included in the MSCI Japan ESG Select Leaders Index rose to 700 from 500 as coverage of ESG evaluation expanded for the parent index in December 2018.

“As the scope of ESG scoring expands to small cap stocks,” said the report, “ESG index performance will be able to benefit more from the small cap effect and smaller companies will have an incentive to improve their ESG scores.”

The fund measures the ESG score of its equity portfolio by using ESG ratings by FTSE and MSCI, and calculating the weighted average ESG scores for each according to the market capitalization weight of each issue in GPIF’s portfolio. The GPIF then compares these scores to those for the whole market by calculating the ESG scores of market representative indices, using TOPIX for domestic equities and the MSCI ACWI (excluding Japan) for foreign equities.

According to GPIF, results showed that the fund’s equity portfolio’s ESG score for both the FTSE and the MSCI continued to improve for domestic and foreign equities. The results also showed that there was little difference between the ESG scores of the index portfolios and those of the GPIF holdings for both domestic and foreign equities for the FTSE and MSCI.

“These results were most likely mainly due to the fact that GPIF’s assets are largely allocated to passive investment funds, whose performance tracks the performance of their benchmarks,” the report said.

Because large companies tend to perform better in ESG information disclosure they receive higher ESG scores. As a result, a market cap-weighted average ESG score is likely to be higher than a simple average. For example, FTSE’s market cap-weighted average ESG score for Japan’s TOPIX stock benchmark is 2.61, while the simple average ESG score for domestic equities is 2.18. The difference in values is mainly attributed to the difference between weighted average and simple average calculation methods.

Although GPIF calculated the country-level average ESG score for all surveyed companies, ESG scores vary widely among companies within the same country. Japanese companies rank at the top among major countries in terms of the percentage of companies contacting MSCI over the course of the index provider’s ESG scoring process, which indicates an increased interest among these companies with respect to ESG scores. They are expected to further improve their handling of ESG issues and information disclosure going forward, which will help elevate their ESG scores even higher, said the fund.

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