FTSE Russell Convenes | Episode 2, Season 1

The ghosts of sustainable investing's past, present and future

December 08, 2021

Twenty years ago, investors mocked the launch of the first ESG focused index called FTSE4Good. But two decades later, interest in ESG indices is driving some of the biggest allocations of capital today. FTSE Russell Americas Head of Sustainable Investment Tony Campos discusses what has changed since then, what’s driving markets’ and companies’ need for certainty and what the world of sustainable investing might look like in 2026.

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FTSE Russell is an index provider and research houseunder the LSEG umbrella.They specialize in convening the best ideas on evolvingmarket trends and helping to develop strategiesfor global investors.In this series, we look at the evolutionof the biggest of today's trends.Twenty years ago, investors mocked the launchof the first ESG focus index called FTSE for Good.But two decades later, interest in ESG indices is driving someof the biggest allocations of capital today.To understand more about how this happened,I chatted with Tony Campos, Head of Sustainable Investmentsat ELSEG.Okay, so Tony, I want to, if you don't mind, go a little bitback to basics.I want to know, you say you've been there 17years, were there even anyreal like ESG style indices even back then?And like going over the last 17 years, how has that productchanged and who are your clients and who uses the productsthat you have?20 years ago, FTSE launched FTSE for Good,one of the first ever global ESG indexes.So that actually predates my time at the company.I believe I was the fourth person to joinfocused on ESG in 2004.But FTSE for Good at the time was quiteimportant and different.Now, if we think over the last 20years, I say oftensustainable investment has changed a lot over thattime, but one thing has really stayed consistent,which is a lack of definitions and standards.That's one of the biggest challenges we have.Can I ask about just FTSE for Good?So back then, how would FTSE have gone about constructingthat index?So the real concept here is you start with your standard marketcap weighted universe because youwant broad exposure.Our clients are looking for broad,diversified global equities.But big liquid names as well.Exactly.Now, from an ESG perspective, you have to define howyou're going to set transparent rules for how you will definewho gets in and who gets out.For FTSE for Good, we look at that through twodimensions of corporate ESG practices and behavior.One is thinking about company conduct.So what's the risk management and impactof the company's day-to-day operations from anenvironmental and social perspective?But you can also think about the impact of the company'sproducts and their use in society.Some can be negative, some can be positive.So, it's possible to have a companythat makes environmentally beneficial productslike solar panels or wind turbines,but treats their employees poorly, or maybe manufacturesthose products in an environmentally harmful way.Equally, you could have a company who,maybe their products are focused on,produce something like tobacco, but they do so in a fairlyenvironmentally thoughtful way.Okay.We don't just look at environmental impact,it's a lot about corporate culture as well.So how about corporate culture and the way peopletreat employees and diversity?How do you measure that?So that's a big challenge.It's one that I think the industryis pretty aware of, but ultimately the disclosurefrom companies is not yet sufficient enough to allow usto make fully informed decisions about diversity and inclusion.Part of the reason for that is the publicly available datathat's provided is sparse and difficult to compareacross time, across regions, across sectors.As the years go by and ESG becomes a bigger and biggertopic, are there becoming ways of measuring ESG more easilywith companies and does that then help you create products,create indices which are more aligned with what you're tryingto achieve?Yeah, absolutely.So there's been a great developmentin the quality of data that's being disclosedand therefore the tools and models that can utilize thatdata.Now that quality of disclosure still isn't as good as it needsto be, but it's much better than wherewe were certainly 20 years ago when FTSE for Good launched.So we'll come on to the future in a sec,but let's go back to FTSE for Good.So that was really the sort of pioneering product which Iimagine at the time didn't probablyget a huge amount of attention because peoplesimply want to make money.It did get a lot of attention.Oh, I'm sorry.When it was launched, it was panned in the UK press.Oh, I see, okay.And so there was an interesting amount of pushbackfrom UK listed companies at the time.However, I think since then, the nature of that engagementfrom companies with the ESG agenda, particularly as it comesto ratings and indexes, has changed pretty dramatically.So talk about the last 15 years and how products have increasedand exactly how they're designed and built and whatyour involvement is there.So the main client base for us is going to be large assetowners and investment managers.Now the use of indexes for those investors is often as the basisfor passive equity allocation in our case.So they're using market cap weighted indexesto get their exposure to particular markets.And from an ESG perspective, you can introduce criteriaand rules to help inform how that index gets created.A lot of the work we're doing today is specifically focusedon ensuring we match the underlying indexuniverse and risk return profile.So there's no discrepancy in performance or risk,but you are getting that ESG impact.Right.Five to ten years ago, how many of your clientswould have a specific ESG mandate, and how many sortof now do, and what's the dynamic of thatchange?So how many people are, basically what's the demandfor that product like?There's two different answers really.One is on the institutional side,the other is more for retail and individualinvestors.On the institutional side, those sortof thematic investments or allocations specific to ESGstrategies are not as common.What we're seeing there is large asset owners,like some of the biggest pension plans in the world,looking to not put specific money into ESGportfolios, but rather integrate ESGinto their standard investment allocation and strategies.That means for us, re-engineeringtheir standard traditional benchmarks to be more ESGintegrated.For individual investors and, say for example,financial advisors, wealth managers,and say an investment product like an ETF, you are often morefocused on thematic ESG concepts and impact.So you're probably being a little bit more strict on someof the ESG criteria to be able to demonstrate howthe index is different and what impact you're getting.And Tony, who ultimatelymakes the decision between which companies are in and whichcompanies are out?Is there a committee or are you in charge of that?So one of the benefits of indexes is they're allrules-based and transparent.Coming back to my original commentaround lack of standardization and definitionshere, the reality is there's a rangeof preferences for sustainable investmentin ESG.So the rules for any index will determine whogets in and who gets out.But just like any index, those decisions have somesubjectivity in them.If we're dealing with an index product that's meant to be veryexclusive, what we would classify as a kindof best-in-class type group, then those rules will be veryrestrictive.If we're trying, on the other hand,to match benchmark-like returns with some ESG improvement, maybecarbon reduction, those rules could be quite different.And in that case, we need to make sure that we'retransparent.We need to make sure the rules are available so clientscan understand what they're buying because there's no oneway to do ESG.Have you seen real significant pickup and demand on both the institutional andretail side over the past few yearsand what's the dynamic of that been?Yeah, it's been pretty remarkable.So if we look at just some recently published numberson our assets passively tracking our sustainable investmentindexes, as of June last year it was about $60 billion in AUM.As of June this year about $160 billion.So pretty great growth.What's driving that is a few things.On the retail side what we're seeing is more fundflows into existing products.So ETFs that use some of our indexes are generatingmore and more asset flows.Part of the reason for that is more financial advisorsare becoming aware and comfortable allocatinginto ESG solutions.It also helps some of those ETFs have now been around for threeyears, have an established track record.On the institutional side, what we're seeing is demandfor climate-specific solutions.A lot of the largest asset owners in the worldthink about climate change as the number one riskfor their time horizon.And what they're looking to do is make sure that their indexes,which they often, you know, passively track for their globalequity exposure, are aligned for a climatetransition in the future.We help them do that by re-engineering the benchmark,essentially re-weighting companiesrather than deciding some companies come out,some companies come in.We want to keep that broad exposure,we just want to weight more to the leadersand underweight some of those that may be left behind inthe climate transition.And for asset owners, that's a big part of the demand.Now, you said it went from $60 billion to $160billion, which is obviously great, but Ithink in the grand scheme of things,these are still relatively small numbers.So, I mean, can you make any kind of prediction about whatyou think that number goes to?And, you know, without getting toopolitical, what needs to happen to people really wake upand dedicate a significant amount of their portfolioto ESG?Is it a price on carbon?Is it tax changes?What's your current view?So for the first question, I think it's reallyimportant to think, yes, this is still a very small partof the market from that perspective of assets tracking.We've seen an explosion in new investment solutionsand products, an explosion in AUM into those products,but it's still starting from a very small base.But I think it's important to remember that ESG is not justabout sort of products and investment products.For a lot of our clients, it's about process.So particularly for active managersthat maybe aren't managing an ESG fund or marketing an ESGfund, it's about their investmentdecision making process.So a big part of this is about data and information,benchmarking, so they can improve the waythey make investment decisions to incorporate environmental,social, and governance issues.That doesn't mean that the strategy is an ESG strategy,it might still be a U.S.Today, we're going to be talking about how investors are changingtheir mind in terms of dedicating more money to ESG.Is that forcing these boards of directors and senior peopleat companies to readjust their priorities?Yeah, it's really forcing those companies, first and foremost,to be transparent about what their approach to managing ESGrisks are.So right now, there's still a huge needfor more and better data on the way companies manage ESGrisks.In pretty much every market globaly,with very few exceptions, this is voluntarily reporteddata.Today, I'm going to be talking about the market-led initiativesthat are helping develop frameworksfor corporate reporting, particularly around thingslike climate-related risks.So that's helping companies bring more informationto the market, but that's being market-led.So some of the biggest asset owners, asset managersare putting pressure on the issuersto bring more information to the market.Do you feel more hopeful about the future after forumslike COP26?Do you feel that enough is being done?So I think optimism, yes.Caution, yeah, absolutely.It's still a very scary situation we're in.There is great momentum and one of the benefits or Ithink main outcomes of COP26 will be a recognitionthat finance is at the center of climate change.And now there's going to be an increased focus on improvingthe data to the market, establishing that marketinfrastructure for climate risk in particular,so that investors can make more informed decisions.Now, the key ingredient that is missing is still a priceon carbon.Let's talk about the price on carbon briefly,because when do you foresee that happening?Is it something that's going to happen in the short term,or is this something that gets kicked down the road?It's really hard to say.I think one thing that we can take some positive momentumfrom is the fact that investors are starting to act evenwithout that price on carbon.Because am I right in thinking that even some of the large oilcompanies are even asking for this as well?So you do feel that even large corporates are on board?Well, markets and companies want certainty,and that will help everyone make some of theselonger-term decisions.Right now, it's a question of are we going to be slammingon the brakes or how gently can we slam on the brakes,perhaps, is a better way to think about it.Now, many of the particularly assetowners that we're working with that are trying to thinkabout the low carbon transition and ready their portfolios,what they're trying to do is, you know, take decisions now,so not waiting, but also giving themselves some flexibility.So from the perspective of an index and data provider,that means, you know, transparent frameworksthat can be effectively ratcheted up or dialed downover time.So the way that we might create a climate transition indexright now could look very different in five years' time.Once the data is better, maybe decarbonisation is happeningmore rapidly and you need to be a little bit more aggressive.At the same time, maybe things go slower or maybethere's a market event that you need to account for.So having the flexibility and the way in which youapply some of these climate risk data models into indexconstruction is really important for the future.So let's talk about the future then, Tony.So kind of a crystal ball question,but if you were to look out five years to 2026,what do you think the world of sustainable investing lookslike now, the world of indices?Yeah, I think we'll certainlysee greater sort of global adoptionof some of the sort of regulatory and marketled initiatives that are coming out of Europe and the EU.So there is a pretty well established sort of frameworkfor classifying green impact coming out of the EuropeanUnion.We'll start to see other markets start to adoptsimilar taxonomies, if not exactly that,and more disclosure improvement from corporates.But for investors, I think what we'll see is a reallocationof existing capital into more ESG focused solutions,more sustainable focused solutions.For us that means really an asset transition from sometimesmarket cap weighted benchmarks and allocations.So those largest asset owners like your big government pensionplans that today are invested in the market cap weightedRussell US indices or FTSE global indiceswill start to want to take some of that money and put itinto the climate transition aligned versions of thosebenchmarks.So it won't exactly be about new moneybeing allocated in some of those scenarios,but rather a reallocation.And that's a signal to the market around how someof these solutions can be enacted, which will helpraise visibility and also demonstrate for someof the smaller sized asset owners and other investors kindof rules for the road.And just because it's such a hot topic at the moment,the world of digital assets and AI, as those two influencescome into the world of finance, how can you use themto further improve your products or how could theyinfluence the world of investing?Definitely from a data point of view it can be very helpful.So right now a big limiting factor, and this really has beenthe case throughout the last 20 years that we've been workingin sustainable investment, the disclosure from companiescan be a limiting factor.Oftentimes you have to model out data to fill in some gaps,and sometimes you need to look at non-corporate reportedsources of information, media sources, sometimes evenincluding social media sources, and that sort of big dataeffort, unstructured data effort requires certain technologiesto not only bring all that data in,but increasingly to introduce some typeof sentiment analysis into what you're reading.And that's really crucial.It's also very difficult from our perspectivein terms of rules and transparency and objectivitybecause it's really hard to put some structure around that.So there's a balance we have to reach between the useof some of that, those data collection techniquesand assessment techniques versus the transparencywe have to put into the index product.Well Tony, it's been so great chattingwith you.I just want to say thank you so much for your time.Absolutely, my pleasure.Thanks, Teddy.Sustainable investing and the role of ESGin corporate culture was something that was certainlytalked about for 10 years, but it didn't reallytranslate into investment opportunities.Now, due to the rise of indices allowing more direct investmentinto ESG and sustainable themes, capital allocationsare accelerating these trends, creating opportunitiesthat are only going to get bigger and more diversein the future.If you'd like to read more on this topic,please go to footsyrussell.com forward slash researchwhere you'll find much more information.

June, 3, 2021 at FTSE World Investment Forum

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