Today, a wide range of indexed, sustainable funds are available that are constructed on the basis of ESG data (environmental, social and governance) or sustainable indices. In its Sustainable Finance Study 2021, the IFZ Institute for Financial Services of the University of Lucerne meanwhile counts 227 passive, sustainable investment vehicles – that corresponds to 18 percent of the total sustainable fund universe of 1,289 funds. A veritable jungle of index funds and exchange-traded funds (ETFs).
The pressing question is: how do I clear a path through this jungle? What aspects should be kept in mind to find the right indexed, sustainable investment vehicle?
The choice of investment vehicle: ETF or index fund
Before it comes to implementation of the sustainability strategy, the decision must be made between an ETF or an index fund. Exchange-traded funds (ETFs) have the upper hand, particularly in the retail market, while institutional investors have been focusing on index funds for several years. In the case of private investors, the advantages of index funds often fade into the background. However, the exemption from Swiss stamp duty, the lack of costs for market makers and the transparent valuation of index funds at the NAV (= net asset value, i.e. identical to the benchmark index) should be worth considering.
A look at various ESG approaches: To what extent should sustainability be taken into account?
Once the decision has been made to opt for ETFs or index funds, it is time to select the appropriate sustainable approach. The approaches available on the market include:
- Exclusion criteria
- Best in class
- ESG laggards out
- Consideration of climate change through CO2 reduction
- Or a combination of approaches
The explicit consideration of climate change is rather new. Swisscanto Invest already offers the opportunity to invest in index funds that – in addition to integrating ESG criteria – demonstrate a reduction in carbon intensity compared to the benchmark index by at least minus 20 percent. Passive investments can therefore take into account both ESG criteria and aspects of climate change.
Key characteristics of an indexed core investment
Despite all sustainability considerations, the requirements for an indexed core investment must continue to be met.
If a sustainable investment is to meet the requirements of an indexed core investment, classic aspects and key figures of the indexed investment remain important:
- Representative coverage of the market
- The tracking error compared to the benchmark index, which is practically always a standard index from the investor's perspective, not an ESG index
- Proximity to a relevant standard benchmark index through sector neutrality, portfolio optimisation and low turnover
- For indexed bond portfolios, there should be few deviations in terms of credit ratings and duration compared to the standard benchmark index
Opening up the jungle
The transparency and comparability of the sustainable products available on the market remain a challenge for investors. It’s still a difficult choice. Our task is to provide support here with transparency.
Improvement through standardisation
Sustainable investments have experienced explosive growth as a response to the Paris Agreement, the 17 Sustainable Development Goals and the EU Action Plan. Now, a wide range of stakeholders for sustainable investment have a strong need to cut through this jungle and find a clear path. A process of standardisation has begun, driven by investors and asset managers in order to accelerate capital allocation in line with sustainable strategies. Improvements in the availability and transparency of ESG data and the performance of investment stewardship make a significant contribution here.
For institutional index investors, despite all their sustainable ambitions, replicating the risk and return characteristics of the benchmark index will continue to remain the key factor for indexed investment success.
