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08 Mar 2019

Follow the ESG Leaders

Our ESG range, and our ESG practices, are growing all the time, with the Lyxor MSCI Europe ESG Leaders ETF just the latest addition. We spoke to François Millet, the man at the forefront of this change, to find out why.

Getting a grip on governance

When governance goes bad, portfolios can suffer. One of the most infamous recent examples concerns the charismatic Carlos Ghosn – former Chairman and CEO of the Renault-Nissan-Mitsubishi consortium – and his arrest for possible financial misconduct in November last year. Corporate governance and the dangers of leaving too much power unchecked in too few hands have been in the spotlight ever since. It is possible to get a greater grip on governance, but how?

Partnering up

The answer – if you don’t have the time or expertise to carry out due diligence on each and every one of the hundreds of stocks you may hold in your portfolios – is to ally yourself with someone that does. That’s why we chose to partner with index provider and ESG research specialist, MSCI, for our ESG ETFs.

MSCI has over 40 years of experience in collecting, cleaning and standardising ESG data. When building their ‘best-in-class’ ESG Leaders index series, MSCI’s goal was to include companies with the highest ESG rating in each sector and ensure a 50% sector representation vs. the broad parent index.

Their Trend Leaders benchmarks require that same high ESG score, and that same strong market representation, but they also take the score’s trend into account. If a company has improved its score, there’s a greater likelihood of it being selected in the index and vice versa.

  

Why it’s worth going the extra mile

In contrast, conventional SRI ETFs tend to only focus on the top 25% of companies left in each sector. They come with additional risks because of their lesser diversification, diminished market representation and intra-sectorial biases.

For example, in MSCI’s USA SRI index, 50% of the IT sector weighting is represented by one stock, Microsoft. Taking the “top 25” approach also leads to a greater bias towards large-caps. That may not always be the worst of ideas, but the Leaders series give you a more rounded or blended exposure.

And it’s worth thinking about what you’re actually trying to achieve with your money. Are you happy just to go with what’s already best-in-class, or are you wanting to support those companies making the most sizeable, positive changes to the way they do business and how they affect the world around them? Rewarding momentum could, in the long run, prove even more influential and even more valuable.

On values vs. integration

One of the key differences between the SRI indices and the Leaders series is on the use of screens. The SRI indices actively avoid companies that are inconsistent with specific ESG values, most obviously those with a high negative social or environmental impact. They could be described as a choice based on personal or organisational values.

However, the Leaders series integrate more ESG data, and more material ESG data, in the investment process. It’s a methodology designed to significantly improve the ESG profile of a portfolio and manage risks associated with controversial businesses and practices without altering market representation.

That said, the Leaders indices do incorporate an element of exclusion, notably of companies involved in serious ESG related controversies or those involved in certain business activities such as alcohol, gambling, tobacco and weaponry.

Awareness is all 

That 50% coverage of the parent index, in our view, gives you an exposure that’s more in line with the original benchmark. The tracking error is lower too. Several of these products have also shown they can outperform their market-cap equivalents, notably in Europe*. In our view, the Leaders and Trend Leaders approaches make for better proxies for the original parent exposure than the pure SRI equivalent – meaning you can have a positive, socially aware impact on the world around you without dramatically altering the structure of your portfolio.  No other provider currently offers you exposure to all of these indices.  

We won’t go gently

We all have a duty of care to the world around us. In investment terms, that means delivering the best ESG funds we can and reporting on the effects our funds have on the world around them in the most transparent way. But there’s more to it than that.

Embedding the need to do good in every facet of our working lives and the lives of others is one of our core missions. That’s why, unlike most other passive managers, we engage directly with companies to induce them to improve their sustainability practices.

We also look use the voting rights given to us as large shareholders to influence companies. In 2018, we voted on more than 2,600 resolutions and €14bn+ of equity positions. We cast negative votes in 22% of resolutions and voted “against” at least once in 77% of the general meetings we have attended. Most of those votes have involved executive pay as well as board composition, remuneration and issues of transparency. We plan to become even more activist still**.

Passive managers don’t have to be silent; far from it. We can be as loud as active managers – if not more so – when it comes to keeping watch over companies and influencing management to act in the best interests of shareholders, society and the environment.

Our voting record explained

*Source: Lyxor International Asset Management, MSCI, Bloomberg, Data as at 28/02/2019. Past performance is not a reliable indicator of future performance. **Source: Lyxor International Asset Management as of 31 December 2018. Included €19.6bn of Assets under Advisory.


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Conflicts of interest 

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.

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