By Reid Steadman, Managing Director, Global Head of ESG Indices and Daniel Perrone, Director, ESG Indices

• The S&P 500 ESG Index aligns investment objectives with environmental, social, and governance (ESG) values.

• It can serve as a benchmark as well as the basis for index-linked investment products. The index’s broad market exposure and industry diversification result in a return profile similar to that of the S&P 500.

• The index uses the new S&P DJI ESG Scores (see page 4) and other ESG data to select companies, targeting 75% of the market capitalization of each GICS® industry group within the S&P 500.

• The S&P 500 ESG Index excludes tobacco, controversial weapons, and companies not in compliance with the UN Global Compact (UNGC). In addition, those with S&P DJI ESG Scores in the bottom 25% of companies globally within their GICS industry groups are excluded.

• Our methodology results in an improved composite ESG score compared with the S&P 500. This holds true in all industries.

INTRODUCTION

An increasing number of investors require indices that are aligned with their investment objectives and their personal or institutional values. The S&P 500 ESG Index was designed with both of these needs in mind.

The S&P 500 ESG Index is broad and constructed to be part of the core of an investor’s portfolio, unlike many ESG indices that have preceded it, which were thematic or narrow in their focus. By targeting 75% of the S&P 500’s market capitalization, industry by industry, the S&P 500 ESG Index offers industry diversification and a return profile in line with the U.S. largecap market.

Yet the composition of this new index is meaningfully different from that of the S&P 500 and more compatible with the values of ESG investors. Exclusions are made related to tobacco, controversial weapons, and compliance with the UNGC. Furthermore, companies with low ESG scores relative to their industry peers around the world are also excluded. The result is an index suitable for investors moving ESG from the fringe of their portfolio to the core.

KEY OBJECTIVES

The methodology of the S&P 500 ESG Index was constructed with two objectives:

• To provide a similar risk/return profile to the S&P 500; and

• To avoid companies that are not managing their businesses in line with ESG principles, while including companies that are.

These two objectives run somewhat counter to each other. Eliminating companies from the S&P 500 necessarily changes its performance. But with further methodological adjustments, the industry composition of the S&P 500 ESG Index is brought back into general alignment with the S&P 500.

METHODOLOGY SUMMARY

Exclusions

Companies are eliminated that:

• Produce tobacco, have tobacco sales accounting for greater than 10% of their revenue, derive more than 10% of their revenue from tobacco-related products and services, or hold more than a 25% stake in a company involved in these activities;

• Are involved in controversial weapons, including cluster weapons, landmines, biological or chemical weapons, depleted uranium weapons, white phosphorus weapons, or nuclear weapons, or hold more than a 25% stake in a company involved in these activities;

• Have a UNGC score that is in the bottom 5% of scores in the eligible universe; [1], [2] or

• Have an S&P DJI ESG Score that is in the bottom 25% of scores within their GICS industry group in the S&P Global LargeMidCap and S&P Global 1200.

SP500 ESG Index Summary

Constituent Selection and Weighting

Once the exclusions are made, the index constituents are selected in the following manner.

1. Companies are ranked by their S&P DJI ESG Score.

2. Within each GICS industry group, companies are selected from the top down by S&P DJI ESG Score until 75% of the float-adjusted market capitalization of the S&P 500 GICS industry group is reached.

The index constituents are then weighted by their float-adjusted market capitalization. Using these rules, the index is rebalanced on an annual basis, after the close of trading on the last business day of April. [3]

S&P DJI ESG Scores

The key criteria for constituent eligibility and selection in the S&P 500 ESG Index are the S&P DJI ESG Scores. The S&P DJI ESG Scores are based on data gathered by SAM, a division of RobecoSAM, through SAM’s Corporate Sustainability Assessment (CSA). The CSA is an annual evaluation of companies’ sustainability practices, covering a wide range of industry-specific ESG criteria.

Data come from either the companies’ responses to the CSA or research done by SAM on publicly available information for companies that do not fill out the CSA. A preliminary score is then calculated for each company as a weighted sum of a number of individual ESG indicators for each company, with each indicator corresponding to a different question in the CSA. The indicators are weighted to eliminate biases among different industries.

This preliminary score is then modified to account for differences that may exist between companies that complete the CSA (where information is provided directly by participating companies) versus companies that are assessed purely on the basis of publicly available information. In an effort to capture underreported or upcoming sustainability issues, the CSA methodology covers ESG indicators that may not be widely reported in the public domain. Scores are then normalized across individual indicators, and then once more at the final score level based on an “anchor” universe, defined as the combination of the S&P Global 1200 and the S&P Global LargeMidCap, resulting in the S&P DJI ESG Score (see Exhibit 3).

Description of S&P 500 DJI ESG Scores

Controversies

When controversies unfold between annual rebalances of the S&P 500 ESG Index, SAM reviews these to consider whether a company’s S&P DJI ESG Score should be reduced. The S&P DJI Index Committee overseeing the index then determines whether the company should be removed.

Controversies monitored by SAM include those related to economic crime and corruption, fraud, illegal commercial practices, human rights issues, labor disputes, workplace safety, catastrophic accidents, and environmental disasters. Once a company is removed from the index, it is not eligible again for a full calendar year.

CHARACTERISTICS OF THE S&P 500 ESG INDEX

The methodology of the S&P 500 ESG Index is constructed to be simple, with straightforward exclusions and a selection process meant to keep the index’s industry weights in line with those of the S&P 500. By virtue of selecting 75% of each GICS industry group’s market capitalization in the S&P 500, industry weights are closely aligned with those of the S&P 500.

This allows the S&P 500 ESG Index to track the S&P 500 closely (see Exhibit 4), while offering improved ESG performance across each industry group (see Exhibit 5).

Fundamental Calculations

The composite ESG score of the S&P 500 ESG Index was 66.72, compared with the S&P 500’s score of 57.76, an increase of 8.96. This composite score is derived by converting each constituent’s S&P DJI ESG Score into a z-score, calculating the weighted average of the z-scores within the index, and once again converting that weighted average into an S&P DJI ESG Score, using the cumulative distribution function with a mean of zero and a standard deviation of one.

S&P DJI ESG Scores are designed to be read as percentiles. A score of 70 means that company has a stronger score than 70% of the companies in that particular industry. A score of 57.76 means that the S&P 500 had a higher score than 57.76% of the companies in the broader universe. As a result, a score increase of 8.96 from the S&P 500 to the S&P 500 ESG is over 21% of the possible improvement that the index could have.

ESG score improvement is most appropriately measured at the industry level, as the S&P DJI ESG Scores are normalized by industry (see Exhibit 5). The average change in ESG score across industries was 10.78.

Overall ESGReturn Profile

The S&P 500 ESG Index tracks the S&P 500 closely, and it has done so despite excluding more than 30% of constituents based on the various eligibility criteria (see Exhibit 6). Realized tracking errors for the one-, three-, and five-year periods were consistently about 1%, and the index volatility was nearly identical to the S&P 500 over the three- and five-year periods.

Historical Returns

CONCLUSION

The S&P 500 ESG Index is designed for investors wishing to integrate ESG factors into their core investments, while not straying far from the overall profile of the S&P 500.

1. The UNGC, which was established in 2000, commits it signatories—companies and nations from around the world—to abide by principles related to human rights, labor, the environment, and anti-corruption. For more information, see www.unglobalcompact.org.

2. Calculated by Arabesque.

3. Please see the S&P ESG Index Series Methodology for more information on the S&P 500 ESG Index

PERFORMANCE DISCLOSURE

The S&P 500 ESG Index was launched January 28, 2019. All information presented prior to an index’s Launch Date is hypothetical (backtested), not actual performance. The back-test calculations are based on the same methodology that was in effect on the index Launch Date.

However, when creating back-tested history for periods of market anomalies or other periods that do not reflect the general current market environment, index methodology rules may be relaxed to capture a large enough universe of securities to simulate the target market the index is designed to measure or strategy the index is designed to capture. For example, market capitalization and liquidity thresholds may be reduced. Complete index methodology details are available at www.spdji.com. Past performance of the Index is not an indication of future results. Prospective application of the methodology used to construct the Index may not result in performance commensurate with the backtest returns shown.

S&P Dow Jones Indices defines various dates to assist our clients in providing transparency. The First Value Date is the first day for which there is a calculated value (either live or back-tested) for a given index. The Base Date is the date at which the Index is set at a fixed value for calculation purposes. The Launch Date designates the date upon which the values of an index are first considered live: index values provided for any date or time period prior to the index’s Launch Date are considered back-tested. S&P Dow Jones Indices defines the Launch Date as the date by which the values of an index are known to have been released to the public, for example via the company’s public website or its datafeed to external parties. For Dow Jones-branded indices introduced prior to May 31, 2013, the Launch Date (which prior to May 31, 2013, was termed “Date of introduction”) is set at a date upon which no further changes were permitted to be made to the index methodology, but that may have been prior to the Index’s public release date.

The back-test period does not necessarily correspond to the entire available history of the Index. Please refer to the methodology paper for the Index, available at www.spdji.com for more details about the index, including the manner in which it is rebalanced, the timing of such rebalancing, criteria for additions and deletions, as well as all index calculations.

Another limitation of using back-tested information is that the back-tested calculation is generally prepared with the benefit of hindsight. Backtested information reflects the application of the index methodology and selection of index constituents in hindsight. No hypothetical record can completely account for the impact of financial risk in actual trading. For example, there are numerous factors related to the equities, fixed income, or commodities markets in general which cannot be, and have not been accounted for in the preparation of the index information set forth, all of which can affect actual performance.

The Index returns shown do not represent the results of actual trading of investable assets/securities. S&P Dow Jones Indices LLC maintains the Index and calculates the Index levels and performance shown or discussed, but does not manage actual assets. Index returns do not reflect payment of any sales charges or fees an investor may pay to purchase the securities underlying the Index or investment funds that are intended to track the performance of the Index. The imposition of these fees and charges would cause actual and back-tested performance of the securities/fund to be lower than the Index performance shown. As a simple example, if an index returned 10% on a US $100,000 investment for a 12-month period (or US $10,000) and an actual asset-based fee of 1.5% was imposed at the end of the period on the investment plus accrued interest (or US $1,650), the net return would be 8.35% (or US $8,350) for the year. Over a three year period, an annual 1.5% fee taken at year end with an assumed 10% return per year would result in a cumulative gross return of 33.10%, a total fee of US $5,375, and a cumulative net return of 27.2% (or US $27,200)

GENERAL DISCLAIMER

Copyright © 2020 S&P Dow Jones Indices LLC. All rights reserved. STANDARD & POOR’S, S&P, S&P 500, S&P 500 LOW VOLATILITY INDEX, S&P 100, S&P COMPOSITE 1500, S&P MIDCAP 400, S&P SMALLCAP 600, S&P GIVI, GLOBAL TITANS, DIVIDEND ARISTOCRATS, S&P TARGET DATE INDICES, GICS, SPIVA, SPDR and INDEXOLOGY are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”). DOW JONES, DJ, DJIA and DOW JONES INDUSTRIAL AVERAGE are registered trademarks of Dow Jones Trademark Holdings LLC (“Dow Jones”). These trademarks together with others have been licensed to S&P Dow Jones Indices LLC. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. This document does not constitute an offer of services in jurisdictions where S&P Dow Jones Indices LLC, S&P, Dow Jones or their respective affiliates (collectively “S&P Dow Jones Indices”) do not have the necessary licenses. Except for certain custom index calculation services, all information provided by S&P Dow Jones Indices is impersonal and not tailored to the needs of any person, entity or group of persons. S&P Dow Jones Indices receives compensation in connection with licensing its indices to third parties and providing custom calculation services.

Past performance of an index is not an indication or guarantee of future results.

It is not possible to invest directly in an index. Exposure to an asset class represented by an index may be available through investable instruments based on that index. S&P Dow Jones Indices does not sponsor, endorse, sell, promote or manage any investment fund or other investment vehicle that is offered by third parties and that seeks to provide an investment return based on the performance of any index. S&P Dow Jones Indices makes no assurance that investment products based on the index will accurately track index performance or provide positive investment returns. S&P Dow Jones Indices LLC is not an investment advisor, and S&P Dow Jones Indices makes no representation regarding the advisability of investing in any such investment fund or other investment vehicle. A decision to invest in any such investment fund or other investment vehicle should not be made in reliance on any of the statements set forth in this document. Prospective investors are advised to make an investment in any such fund or other vehicle only after carefully considering the risks associated with investing in such funds, as detailed in an offering memorandum or similar document that is prepared by or on behalf of the issuer of the investment fund or other investment product or vehicle. S&P Dow Jones Indices LLC is not a tax advisor. A tax advisor should be consulted to evaluate the impact of any tax-exempt securities on portfolios and the tax consequences of making any particular investment decision. Inclusion of a security within an index is not a recommendation by S&P Dow Jones Indices to buy, sell, or hold such security, nor is it considered to be investment advice. Closing prices for S&P Dow Jones Indices’ US benchmark indices are calculated by S&P Dow Jones Indices based on the closing price of the individual constituents of the index as set by their primary exchange. Closing prices are received by S&P Dow Jones Indices from one of its third party vendors and verified by comparing them with prices from an alternative vendor. The vendors receive the closing price from the primary exchanges. Real-time intraday prices are calculated similarly without a second verification. These materials have been prepared solely for informational purposes based upon information generally available to the public and from sources believed to be reliable. No content contained in these materials (including index data, ratings, credit-related analyses and data, research, valuations, model, software or other application or output therefrom) or any part thereof (“Content”) may be modified, reverseengineered, reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of S&P Dow Jones Indices. The Content shall not be used for any unlawful or unauthorized purposes. S&P Dow Jones Indices and its third-party data providers and licensors (collectively “S&P Dow Jones Indices Parties”) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Dow Jones Indices Parties are not responsible for any errors or omissions, regardless of the cause, for the results obtained from the use of the Content.

THE CONTENT IS PROVIDED ON AN “AS IS” BASIS. S&P DOW JONES INDICES PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Dow Jones Indices Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs) in connection with any use of the Content even if advised of the possibility of such damages.

S&P Global keeps certain activities of its various divisions and business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain divisions and business units of S&P Global may have information that is not available to other business units. S&P Global has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

In addition, S&P Dow Jones Indices provides a wide range of services to, or relating to, many organizations, including issuers of securities, investment advisers, broker-dealers, investment banks, other financial institutions and financial intermediaries, and accordingly may receive fees or other economic benefits from those organizations, including organizations whose securities or services they may recommend, rate,
include in model portfolios, evaluate or otherwise address.

The Global Industry Classification Standard (GICS®) was developed by and is the exclusive property and a trademark of S&P and MSCI. Neither MSCI, S&P nor any other party involved in making or compiling any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

SAM AG, Josefstrasse 218, 8005 Zurich, Switzerland its related and affiliated companies (“SAM”) provides ESG research data derived from its proprietary corporate sustainability assessment for use with the S&P Dow Jones Indices. SAM shall not be liable in relation to any direct, indirect or consequential damages in relation to the S&P Dow Jones Indices offering nor any application of SAM ESG research data. SAM disclaims all warranties, expressed or implied, including, but not limited to, implied warranties of merchantability and fitness for any particular purpose.