We tend to look back at the past and marvel at the changing trends in clothes, food and entertainment. Trends in investment decisions can also undergo quite radical change, although usually for more fundamental reasons than simply personal taste. The FTSE Russell Smart Beta 2017 Global Survey Findings from Asset Owners report has revealed growing interest in both smart beta and sustainability investing over the last few years. As asset owners have become increasingly interested in these two areas, the idea of merging the two gained momentum. Is there a way to combine the two approaches that could maximize the desired exposures to each?
In November 2016, FTSE Russell launched our first "smart sustainability" index—the FTSE All-World ex Controversial Weapons Climate Balanced Factor Index. This index is constructed using the FTSE All-World Index as a base, applying both climate and factor adjustments. As the table below demonstrates, the smart sustainability index first excludes some controversial exposures and then uses three sustainability parameters and four factor tilts. The result is a single index designed to maximize the desired factor and sustainability exposures.
Smart Sustainability framework construction
Source: FTSE Russell.
The chart below illustrates how integrating the two considerations into one index can maximize the desired exposure to each. In this example, the desired exposures are to the value factor and to low operational carbon emission. In the first column — a value factor index alone — the exposure to value is high but exposure to low carbon emission companies is reduced. In the second column, we see what happens to exposure if the focus of the index is solely on carbon emission reduction: there is increased exposure to low carbon emission companies with little effect on exposure to the value factor. Now let’s see what happens when we combine the two.
Factor exposure and sustainability interactions
Source: FTSE Russell Data as at May 22 2017. For illustrative purposes only.
The third column in our example above shows that by creating a composite of the value factor index and the low carbon emission index we can increase exposure to both the value factor and to low carbon emission companies. However, in a composite of two independently designed indexes there is compromised exposure to both value and low carbon emission and we would expect some inherent counteraction to occur. To avoid this pitfall, the smart sustainability index uses a system of sequential tilts applied consistently to the risk premia factors as well as to sustainability parameters within a single index. And indeed, in the final column we see that the single index approach does increase the desired exposures to both the value factor and the sustainability parameter.
The combination of these two popular considerations appears to yield a more efficient means of accessing the desired exposures. FTSE Russell aims to provide indexes that can address the evolution of asset owners’ investment preferences towards a more sophisticated approach to sustainability investing than in the past.
Please see our website for more detail on the 2017 Smart Beta Survey. For more detail about smart sustainability, listen to our recent webinar. See also the video by Mark Makepeace, CEO of FTSE Russell, on ESG benchmarking and asset owners' increasing focus on ESG.
© 2017 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE TMX Global Debt Capital Markets Inc. and FTSE TMX Global Debt Capital Markets Limited (together, “FTSE TMX”) and (4) MTSNext Limited (“MTSNext”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE TMX and MTS Next Limited. “FTSE®”, “Russell®”, “FTSE Russell®” “MTS®”, “FTSE TMX®”, “FTSE4Good®” and “ICB®” and all other trademarks and service marks used herein (whether registered or unregistered) are trade marks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, or FTSE TMX.
All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for any errors or for any loss from use of this publication or any of the information or data contained herein.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the Indexes for any particular purpose to which they might be put.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group index data and the use of their data to create financial products require a licence from FTSE, Russell, FTSE TMX, MTSNext and/or their respective licensors.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.