IN THIS LIST

A Matter of Degrees: Aligning ESG Strategies with the Paris Agreement

A Guide to S&P Decrement Indices

Indexing Liquid Alternatives

Talking Points: Capturing the Growth of the Australian Technology Industry

The S&P 500 ESG Index: Defining the Sustainable Core

A Matter of Degrees: Aligning ESG Strategies with the Paris Agreement

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Jaspreet Duhra

Managing Director and Head of EMEA Environmental, Social, and Governance (ESG) Indices

Having already witnessed some of the consequences of climate change around the world, more and more investors are now factoring ESG into their investment decisions. Enter the S&P PACT™ Indices (S&P Paris-Aligned & Climate Transition Indices), created to give market participants access to strategies designed to be compatible with limiting global warming to 1.5°C.

We talked with Francois Millet, Managing Director and Head of
Strategy, ESG and Innovation at Lyxor ETF, and Jaspreet Duhra, Senior Director and Head of EMEA ESG Indices at S&P DJI, about the evolving role of ESG in mainstream investing and how these indices may help market participants envision a less fraught future.

Indexology Magazine: Why do you think ESG investing is becoming more important to investors around the world, and do you think the recommitment to climate initiatives in the U.S. adds to the momentum?

Francois: The pandemic triggered a realization that humans are extremely dependent on natural systems. Many investors now work on the widespread conviction that climate and exponential inequalities are major risks—and that mitigating these risks, and building a more inclusive and resilient world with long-term focus, is a precondition for financial stability.

ESG investments captured more than 50% of net inflows to ETFs in Europe last year. This more than offset the negative influence of the official U.S. position on the Paris Agreement at the time. But it's great to see the U.S., which produces around 15% of the world's greenhouse gas emissions, rejoining the Agreement. This recommitment to climate initiatives should bolster the ESG transformation that's already underway and make the Paris Agreement stronger than ever.

Indexology Magazine: Why were the S&P PACT Indices created, and what specific climate goals do they seek to achieve?

Jas: The world is on a dangerous trajectory of warming that is already impacting society and the economy. Regulators are taking action and as investors increasingly take stock of the climate risks in their holdings, more and more are looking to align their investments with a scenario in which warming increases by no more than 1.5°C. The S&P PACT Indices were created with this goal in mind.

The indices are designed to meet the minimum standards for EU Paris-aligned Benchmarks and EU Climate Transition Benchmarks, which means that in addition to lowering carbon emissions relative to their underlying benchmarks, the indices also seek to decarbonize on an absolute basis at a rate of 7% year-on-year. This is the rate of decarbonization required to achieve net-zero emissions by 2050 and limit warming to 1.5°C according to the Intergovernmental Panel on Climate Change. Interestingly, these indices are also designed to maintain the same exposure to high-climate-impact sectors as their benchmarks, which means the decarbonization can't be achieved by just tipping all the weight into low-climate-impact sectors.

We have also gone beyond the EU Low Carbon Benchmark requirements by aligning with the recommendations of the TCFD (Taskforce on Climate-related Financial Disclosures). We believe that the TCFD approach of breaking climate issues into transition risks, physical risks, and opportunities provides a holistic assessment. It's particularly important that our index takes climate change's physical risks into account, as we already see these risks playing out today.

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A Guide to S&P Decrement Indices

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Tianyin Cheng

Senior Director, Strategy Indices

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Izzy Wang

Analyst, Strategy Indices

INTRODUCTION

Decrement indices have gained popularity as the underlying assets of equity-linked structured products in Europe and Asia. According to Structured Retail Products, among the 318 products across asset classes in France that matured or autocalled between April 2018 and March 2019, more than 32 were linked to decrement indices.

One of the reasons behind this recent popularity is the low interest rate environment that has emerged since the 2008 Global Financial Crisis, which has posed challenges for structured product issuers to design attractive products. This environment triggered a search for new underlying assets or strategies that might deliver cheaper optionality. Decrement indices aim to provide a solution to this challenge. S&P DJI has developed a flexible, transparent, and rules-based decrement index framework, which features:

  • Globally accepted, independent underlying indices such as the S&P 500®;
  • Transparent methodology based on the S&P DJI decrement framework; and
  • Customization options in underlying index and decrement parameters.

Exhibit 1

How Decrement Indices Work

A decrement is an overlay applied to an underlying index. It is constructed by periodically deducting a predefined fee, either in the form of a fixed percentage or index points, from the underlying index (see Exhibit 1).

Given an underlying index, decrement indices can be calculated in different ways, depending on which parameters are chosen (see Exhibit 2). All the parameters can be customized. Decrement type and application are the most important parameters, as they primarily determine the amount of decrement deduction and how it is applied to an underlying index.

Exhibit 2


Decrement Type

The performance reduction applied to an underlying index can be either fixed percentage or fixed point. The logic of the fixed-percentage decrement is that dividend yield tends to be stable over the long term. During the past 10 years, the trailing 12-month dividend yield for the S&P 500 was relatively stable, at about 2%. On the other hand, a fixed-point deduction assumes a relatively high level of stability in dividend amounts in the short term, as companies are inclined to maintain more stable dividend policies compared with their earnings.

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Indexing Liquid Alternatives

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Tianyin Cheng

Senior Director, Strategy Indices

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Phillip Brzenk

Senior Director, Strategy Indices

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Rupert Watts

Senior Director, Strategy Indices

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Fiona Boal

Head of Commodities and Real Assets

INTRODUCTION

Alternative investment strategies, including absolute return long-short, risk parity, global macro, or relative value, have historically been used only by the most sophisticated market participants, such as institutional investors and hedge funds.  Market participants often seek alternative investments to improve diversification in portfolios, since these strategies tend to exhibit low correlations to the more traditional financial market asset classes of equities and fixed income.  Better diversification may lead to higher risk-adjusted returns and lower drawdowns in a portfolio relative to one that only holds stocks and bonds.

However, a drawback of some alternative investments is that they can be relatively illiquid and only appropriate for long-term investment horizons without short-term liquidity needs.  Conversely, investing in alternative strategies through liquid instruments, such as exchange-traded futures contracts, can reduce the illiquidity risk, making them a good fit for a broader range of market participants.  These strategies, commonly referred to as liquid alternatives, give market participants better access to alternative investments.  Additionally, liquid alternatives in an index format provide a systematic rules-based methodology, transparency in pricing, and typically lower cost structure.

There is a wide range of liquid alternative strategies with differing characteristics or key properties as the underlying rationale for construction.  A liquid alternative strategy could vary from directional to market neutral to trend following.  Directional strategies are typically long-only with low-to-moderate correlation to broad equities, seeking higher risk-adjusted returns relative to the market over the long term.  Market-neutral strategies seek to provide purer exposure to certain risk premia in the marketplace by stripping out the market beta.  These are typically long-short and target a zero beta, and thus tend to exhibit a low correlation to broad equities.  A trend-following strategy seeks to capture price trends by going long or short different assets based on recent price movements, and its correlation to broad equities varies from positive to negative over time.  To have a large opportunity set and proper diversification, a trend-following strategy often incorporates multiple asset classes, such as equities, fixed income, currency, and commodities.

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Talking Points: Capturing the Growth of the Australian Technology Industry

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Michael Orzano

Senior Director, Global Equity Indices

The S&P/ASX All Technology Index highlights a unique and innovative segment of the Australian market.

  1. Why was this index introduced?

In recent years, ASX-listed technology companies have experienced substantial growth in terms of both number of companies and market capitalization. In the past six years, the number of S&P/ASX All Technology Index constituents nearly tripled from 24 to 69, while the total market capitalization of these companies increased tenfold from AUD 17 billion to about AUD 170 billion.

In a market heavily concentrated in banks and natural resource companies, there is significant demand for an index that captures the Australian technology sector in a comprehensive yet precise way. Importantly, the technology segment measures a unique, innovative part of the market that remains a small portion of the broader Australian share universe. We also expect the index to increase the visibility of technology-related businesses listed on the ASX, which should support further growth of the sector over time.

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The S&P 500 ESG Index: Defining the Sustainable Core

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Daniel Perrone

Director and Head of Operations, ESG Indices

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Reid Steadman

Managing Director, Global Head of ESG

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Margaret Dorn

Senior Director, ESG Client Engagement North America

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Mona Naqvi

Head of ESG Indices, North America

The launch of the S&P 500 ESG Index in April 2019 signaled an evolution in sustainable investing.  Indices based on environmental, social, and governance (ESG) data were no longer simply a means for companies to declare their sustainability credentials or tools to manage tactical investments playing a minor role in investors’ portfolios.  The S&P 500 ESG Index and other such indices were built to underlie strategic, long-term mainstream investment products.

For decades, the prospect of inclusion in ESG indices like the Dow Jones Sustainability Indices has encouraged companies to manage their businesses with various stakeholders and objectives in mind.  However, these pioneering, best-in-class indices tended to be narrow, including only a small selection of the top ESG performers.  This presented challenges to individual and institutional investors who were concerned about the risks inherent in highly concentrated portfolios defined by these indices.

The S&P 500 ESG Index addressed the need for an index that incorporates ESG values while offering benchmark-like performance.  Intentionally broad—including over 300 of the original S&P 500 companies—the S&P 500 ESG Index reflects many of the attributes of the S&P 500 itself, while providing an improved sustainability profile.  

This paper outlines the characteristics of the S&P 500 ESG Index that have appealed to investors, including:

  • The easy-to-understand methodology behind the index;
  • How “financial materiality” drives index construction;
  • The similar risk/return profiles of the S&P 500 ESG Index and the S&P 500;
  • How the ESG characteristics of the S&P 500 ESG Index are improved compared with those of the S&P 500; and
  • Specific examples demonstrating how the S&P 500 ESG Index methodology sorts and selects companies.

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