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Why choose indexing for sustainable investing

This article is part of
Guide to passive ESG investing

Why choose indexing for sustainable investing
 Pexels/Polina Tankilevitch

Two of the themes that have come to dominate the investment landscape in recent years are the rise of passive investment products and the increased popularity of investments that focus on environmental, sustainable and governance (ESG) concerns. 

But while both themes are in demand, combining them into a single suite of products is also a possibility.

Passive or index funds do not have to blindly buy all of the shares in an index, as smart beta strategies can be used.

Smart beta means giving greater preference to the stocks within an index that meet certain characteristics, and less preference to the stocks which do not. 

Smart beta products were initially created to allow passive exposure to volatility managed and income products, but in recent years products that give greater relative exposure to ESG criteria have come to market. 

Manuela Sperandeo,  EMEA EII head of sustainable indexing, at BlackRock says: “There is a misconception that index investing for ESG means complexity and opaqueness, but that is not the case, because a client can choose what type of sustainable outcome to go for.

"Sustainable indexing strategies range from simply screening out certain businesses, right through to overweighting companies with strong ESG ratings or financing projects with measurable environmental and social impact.

"ESG as a set of preferences is evolving faster than any other segments of the asset management industry in my experience.”

She adds: “Adopting an indexing approach to sustainable investing offers several benefits, such as transparency, clarity and control. We work with the index providers to ensure new product solutions reflect investors’ preference with regard to sustainability.”

Nicolo Bragazza, investment analyst at Morningstar says that ESG index funds carry all of the same advantages as do non-ESG passive investments in terms of offering broad market exposure and low fees, and have abundant transparency around what they are invested in.

He says that a client who just wants a broad-based ESG portfolio will find that index funds fit the bill. 

But he says: “On the other hand, if investors have specific requirements in terms of engagement and/or want their investments to make a measurable impact, it is more likely for them to find what they look for in the active space, where managers have more flexibility in their investment decisions and policies." 

A spokesperson of passive investing firm Vanguard says: “Index funds have the advantage of enabling investors to hold balanced, broadly-diversified, portfolios at a low-cost.

"Those that follow ESG or SRI benchmarks then screen out companies that don’t meet agreed, independent ESG criteria, in a clear and transparent way.

"Nevertheless, it’s important to remember that definitions and approaches to ESG vary widely, as do opinions on the 'right' way to reflect ESG considerations in investments. This is unsurprising – there are a broad range of possible approaches, and people's personal values also differ.