Environmental, social and governance, or ESG, investing has found a solid footing among institutional investors, but the theme is slowly trickling down to advisors and retail investors. With the emergence of ESG-related exchange traded funds, adoption could also continue to pick up pace.
“The merits of ESG investing have been trumpeted for years,” FlexShares said in a recent research note. “So why have asset flows to date lagged across retail and advisor channels? We believe that non-core investment approaches and historically limited risk-adjusted performance versus non-ESG alternatives may have inhibited broad investor uptake. We also believe investors are looking for ESG products that utilize an integrated approach to ESG best practices with enhanced risk-adjusted returns as one of their core portfolio holdings.”
To better bridge the gap between institutional level investment strategies with convenience for the average retail investor, index providers have started to develop rules-based indexing methodologies that could better mimic well-researched investment strategies. For instance, some are relying on key performance indicators, or KPIs, reported by public companies in regulatory filings.
“It is now possible for asset managers to develop and apply systematic investment strategies that evaluate a company’s risk and opportunities by examining its environmental, social and governance indicators,” according to FlexShares.
Joining the new wave of ETF products based on ESG principles, FlexShares has come out with the FlexShares STOXX US ESG Impact Index Fund (NasdaqGM: ESG) and FlexShares STOXX Global ESG Impact Index Fund (NasdaqGM: ESGG).
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The funds are based on the STOXX global ESG Impact Index, which screens companies scoring better with respect to a select set of ESG key performance indicators (KPIs), with the bottom 50% of such companies based on their ESG KPI scores excluded from the Index, as are companies that do not adhere to the UN Global compact principles, are involved in controversial weapons or are coal miners.
“KPI integration improves bottoms-up security selection while removing data-provider bias,” according to FlexShares. “The methodology builds an ESG index by essentially coding at the ‘root’ level versus applying an overlay or top-down ESG strategy; it parallels the best behaviors of portfolio managers when it comes to evaluating, sorting and selecting companies for investment.”
For more information on the ESG theme, visit our socially responsible ETFs category.