Ten years and counting on broadening demand for ESG investment tools

The FTSE4Good index was launched a decade ago, but its senior executive Tony Campos tells Mike Scott that ESG-driven investments are set to break out of their niche

It’s been ten years since the launch of FTSE4Good, an index of companies that demonstrate strong performance on environmental, social and governance (ESG) issues. “FTSE4Good gives investors the tools they need to integrate ESG factors into their investment decision-making processes,” says Tony Campos, FTSE senior executive for responsible investment.
 
The index arose out of changes in the way pension funds were obliged to report on whether they looked at ethical issues and, if so, how. This led “to the emergence of fund managers to cater to those wanting to do something”, Campos said.

Since then, FTSE has expanded into thematic indices, “driven by investor demand for such information,” Campos said. “At the start, it was about looking at environmental and social factors and bringing them into benchmark construction. Over time, the need arose to demonstrate how this approach delivers value from an investment perspective.”

The FTSE Environmental Markets Index Series, developed with Impax Asset Management, was the result. They measure the performance of companies globally “that have significant involvement in environmental technology and business activities, including renewable and alternative energy, energy efficiency, water technology, and waste and pollution control”.

The initial focus on environmental issues arose because it is easier for investors to attach numbers to factors such as greenhouse gases, water use and waste management compared with a social issue such as labour rights. It is also easier to show ‘alpha’ or outperformance from good performance on environmental issues, whereas for some social issues the opposite is true.

However, Campos points out that looking at ESG is about more than outperformance and other issues that investors look at, such as health and safety, are not necessarily about beating the benchmark to be seen as important. “These are potentially very material issues and an investor should be thinking about them.

“Once you set out that classification, you can start to understand the companies active in these areas and you can start to compare like-for-like,” Campos said.

The group also has an index, developed with the Carbon Disclosure Project, that allows investors to incorporate climate change risks into their investment strategy. The Carbon Strategy Index Series identifies companies’ exposure to higher future costs associated with CO2 emissions and weights companies accordingly, rather than using the traditional market capitalisation approach. “Some companies will be better placed to exploit the transition to a low carbon economy. Other companies will see their value diminished if they fail to adapt,” the company says.

Earlier this year, the index introduced ‘the next evolution’, the FTSE4Good ESG Ratings, which will compare the ESG risk and performance profile of every company in the FTSE All World Developed Index. “Users will be able to identify which companies are leaders, which are laggards, and those facing the greatest ESG related risks,” Campos says.

ESG-driven investment is breaking out of its niche and becoming more familiar to mainstream investors and analysts. For example, the group intends to expand its coverage of supply chain labour issues from agriculture and textiles to sectors such as IT.

He adds. “We are going to see a continued evolution of the tools we offer because, over time, it will become clear what works. We will also see growing demand in areas we have not covered yet.”