Blog Posts — December 10, 2021

Flexible approach in use of ESG data is key driver in advancing sustainability indices

As investors incorporate their individual sustainability commitments and goals, the ESG investment landscape has grown to span an entire spectrum of diverse strategies, ambitions and risk considerations.   

At Qontigo, we offer a broad range of STOXX and DAX indices tracking different ESG, sustainability and climate strategies. As with our other indices, they are all transparent and rules-based. However, our ESG indices stand apart through our unique open-architecture approach, which relies on increasingly varied and sophisticated inputs — from a range of sustainability data providers to client’s own datasets — that ensure the accuracy and effectiveness of the indexing outcome.

ESG data is still evolving

Given its importance, ESG data has been the subject of debate since the birth of responsible investing. As investors made their first inroads into the responsible space, they encountered information that wasn’t thorough, uniform or clear enough. One example was to be found in ESG ratings, which differed significantly from one provider to another. 

Since those first days, the quality and coverage of ESG indicators has improved dramatically — even if differences in reporting and standards persist and important gaps in the data remain. Meanwhile, policymakers and the private sector have stepped up efforts to standardize ESG reporting, eliminate the noise around data, and avoid ‘green-washing.’ 

Open architecture allows use of state-of-the-art data

A huge variety in data, on the other hand, can help enrich investment strategies and provide an edge in performance. Qontigo’s approach is to find and leverage the most robust data available for each sustainable investing case. No matter what new approach is envisaged, we are not limited to any single provider, but are free to go where the best data is. We believe that having this freedom and being nimble is the surest way to obtain state-of-the-art, reliable and consistent ESG information. 

Some of the leading providers we collaborate with include Sustainalytics and CDP. The former supplies the ESG scores and norms-based and product-involvement exclusions that feature in the exclusions, integration and best-in-class strategies offered by STOXX and DAX indices. 

From CDP we source emissions data, science-based carbon targets, and rankings to track companies taking action on and understanding the effects of climate change. This input is used, among others, in our Paris-Aligned Benchmarks (PABs), Climate Transition Benchmarks (CTBs)Climate Impact indices and Low Carbon indices.

From our partners at ISS ESG, we obtain climate-related data such as Scope 1 to Scope 3 carbon emissions, as well as science-based climate targets.

Customization drives ESG innovation

Sometimes it is our clients’ proprietary data that form the core of the strategy. In this sense, three very recent collaborations deserve specific mention because they show where the incorporation of ESG data is headed: customization in the overall strategic approach, more comprehensive yet detailed information, combinations of data sources, and innovation in the index methodology. 

One first case is the iSTOXX APG World Responsible Investment (RI) Indices, designed together with Dutch pension provider APG. The indices stand out for two reasons: they are the first to use the Sustainable Development Investments Asset Owner Platform (SDI AOP), an initiative whose dataset helps invest in companies contributing positively to the United Nations’ Sustainable Development Goals (SDGs); and they combine in one same suite incremental layers of ESG, carbon and sustainable development investments (SDI) ambitions, bringing together data from different providers into one solution. 

A second case study is a recently introduced index suite designed in conjunction with Willis Towers Watson, the leading risk management and advisory company. The STOXX Willis Towers Watson Climate Transition Indices (CTI) employ a unique Climate Transition Value at Risk (CTVaR) methodology that quantifies the anticipated impact of an economic transition on equity valuations, enabling investors to address climate-related risks and opportunities with a forward-looking lens that doesn’t rely on the traditional carbon footprint focus. 

One final example of versatility in ESG portfolio construction comes from our recent work with Northern Trust’s FlexShares unit to produce indices that combine their own ESG scoring and quality factor methodology, with ISS climate data and Qontigo’s index construction and optimization capabilities. This process allowed the client to incorporate their proprietary sustainability data, a field where they have over 30 years of experience. 

Lifting the bar in ESG

These use cases help illustrate how data choices are as much an active decision for the investor as they are enablers of investment strategies. More and more investors demand multiple combinations of objectives, ever-more complex products that balance sustainability with tracking error considerations and other investment constraints, and more clarity on portfolio impact and real-world outcomes. 

As such, three factors play a key role in portfolio construction and index design: 

  • customization to adapt to each client need 
  • innovation in risk analytics and portfolio-optimization tools to attain the desired outcomes 
  • full flexibility to incorporate varied ESG input sources 

As assets grow, so does demand for data 

The leverage of data will become even more crucial in coming years, as the concept of impact enters as a third pillar in the historic risk-and-return lens through which investors evaluate their portfolios. A record USD83 billion flowed into passive sustainable ETFs in the first half of this year, taking total assets invested to an all-time high of USD293 billion.1 According to PwC Luxembourg, 77% of European institutional investors plan to stop purchasing non-ESG products by 2022.2

At the same time, new types of sustainability strategies are gaining in importance — impact investing being one of them. This will drive more demand for innovation and sophistication in data and its application. In parallel, regulators’ efforts to standardize ESG labels and practices will further put the focus on index methodologies, very likely creating additional momentum for the industry. 

A trade-off between ESG and active risk

Benchmark-oriented investors may often think about ESG integration as a spectrum, where there is a clear trade-off between the level of integration versus tracking error, or active risk. As the focus grows on reaching sustainability objectives, many investors will naturally start accepting a higher active risk.   

Asset managers and ETF providers can choose from existing, off-the-shelf indices; but the ability to tailor their own sustainable solutions will be a determinant feature in coming years. Regardless of the direction taken to achieve ESG ambitions, being able to navigate through the sustainability data labyrinth will be a decisive factor for a successful journey. In other words, we should take the ESG data challenge and convert it into an ESG data opportunity. 

1 Data from ETFGI. 
2 ‘2022 – The growth opportunity of the century,’ PwC Luxembourg, November 2020.