Amid the growing popularity of incorporating environmental, social and governance factors in investing, a Dutch pension fund is partnering with index-provider FTSE Russell to design a custom passive index that incorporates some of the United Nations’ sustainable development goals.
Pensioenfonds Detailhandel has been incorporating ESG principles for almost five years, says Henk Groot, head of investments for the plan, noting it started mapping its areas of focus to reflect the goals when they were released in 2016. The plan aligned to the goals around decent work and economic growth, climate action and peace, justice and strong institutions.
Read: How companies are stacking up on U.N.’s sustainable development goals
Partnering with Maastricht University, the plan surveyed its members and found they also wanted to focus on the goal around responsible consumption and production, which it then added to its list of focus areas.
“SDG 12 was added after a period of consultation with their members and this bit actually is quite unique and I think it’s worth flagging,” says Aled Jones, head of sustainable investing for Europe at FTSE Russell. Since the Pensioenfonds Detailhandel is for the retail sector, this goal is aligned because it relates to consumption and production, he adds.
When determining the best approach for incorporating the sustainable development goals, keeping it simple and as passive as possible was key, says Groot. He also notes the plan is committed to keeping policy-making separate from managing investments.
“We know there are a lot of investment managers that say, ‘Well, we can do the mapping of ESG factors . . . ourselves and then we will implement it in your portfolio.’ But that didn’t necessarily fit our philosophy of having it separate from the managers. So we decided that the best possible way to integrate SDGs in our portfolio, given our philosophy, is to integrate it into a separate index that we could give to our managers and say, ‘OK, this is the index you should follow in a passive way.’”
Read: Global investors call for government action on climate change
The index will serve as a benchmark for Detailhandel’s developed markets equity portfolio.
It isn’t an impact portfolio and is aligned with the goals instead of directly contributing to achieving them, says Jones.
Also important when transitioning to the index is having a sound understanding of the methodology and framework used by FTSE Russell, says Groot. “It was an exciting project. It consumed a lot of time from both the board and the management company, but we are quite proud that we have managed to [launch] an SDG-focused index.”
Currently, the custom index is only available to Detailhandel, but Jones says FTSE Russell will be launching a standard version that will be available to any investor.
As more ESG indexes become available, Mercer has released a guide for investors looking to navigate the world of responsible indices, highlighting that they aren’t passive investments and should subject to due diligence.
“If passive means a rules-based index construction, that’s certainly what this is,” says Karen Lockridge, principal in responsible investment at Mercer. “But we would say . . . the development of the index construction itself is an active decision. So once you’ve been through that process then certainly the manager would be tracking this index, but it’s an active decision in terms of how that index is going to be constructed and what E, S or G factors are included and how that’s done.”
Read: How Bâtirente takes ESG reporting to the next level
The Mercer guide outlines three broad categories in which responsible indices fall: screening, integration and investments (target thematic or impact investments).
For investors, a good starting point is to have clear and documented investment beliefs prior to considering allocating to a responsible investment index, noted the guide. “We always encourage investors, when they’re looking at anything related to ESG, [to] really clarify their investment beliefs around sustainability and responsible investment and ESG,” says Lockridge. “And then those beliefs would guide their intentions and what they’re trying to achieve with looking for a rules-based index construction or one of these RI indices.”
Once investment beliefs have been developed and investors determine to take an index-based approach, they can then consider key areas including index construction, the choice of index provider and the approach to stewardship, the guide said.
This article was originally published on Benefits Canada‘s companion site, the Canadian Investment Review.